Lords of Finance: 1929, the Great Depression, and the Bankers Who Broke the World (41 page)

No one was quite sure what he had in mind. Berlin was rife with rumors that he might deliberately engineer a new crisis. It was the beginning of what one historian has described as Schacht’s descent into “irresponsibility and unpredictability
⁴³⁷
.” His tendency to “extreme and erratic” behavior seemed to be a deliberate ploy to keep friends and enemies alike guessing. It certainly unnerved his counterparts, Norman and Strong. They feared that consumed as he was by reparations, he might try some reckless and foolhardy gamble to sabotage the Dawes settlement, which would not only plunge Germany into chaos and undermine its fragile new democracy, but might capsize the international monetary structure, which they had so painstakingly put together over the last few years.

They had always worried about Schacht’s tendency to embroil himself in highly visible political conflicts. Never much of a diplomat, he had always been very open in his criticisms of government budgetary policy,
particularly of the states and municipalities borrowing so much abroad. Back in 1925 during the central bankers’ visit to Berlin, Strong had remarked on Schacht’s tendency to “get into political matters which would be [better] left alone by the head of the Reichsbank,” and Norman had gently tried to warn him to be more discreet. But it always seemed that Schacht had enough of an instinct for survival to avoid rocking the political boat too hard. Now, however, he became increasingly indiscreet and strident in his remarks.

One episode in particular brought his confrontation with the government to a head. At a cabinet meeting
⁴³⁸
in June, Schacht launched into a vituperative attack, which left the ministers speechless with outrage. It was typical of the man that having insulted the cabinet, he was not content to leave ill enough alone. He was overhead bragging to the other guests at a private dinner that evening about how he had taken on the politicians. He revealed confidential details of the whole cabinet debate, made insulting comments about individual ministers, dismissed the finance minister as incompetent, and called for his resignation. Even his old supporter Stresemann agreed that Schacht’s behavior was a problem and that his constant and naked self-aggrandizement was becoming intolerable. It was but a small harbinger of things to come.

The miracle of the franc’s recovery may have been good for France but imposed its own financial strains upon Europe. The money drawn back to the franc on Poincaré’s coattails continued to flow in throughout the spring and early summer of 1927, mostly out of sterling. The Banque de France, in an effort to prevent this flood from pushing the franc to uncompetitive levels, kept buying foreign currencies, and by the end of May, had accumulated a foreign exchange war chest totaling $700 million, half of which was in pounds.

The rebound in the financial position of the Banque took Norman completely by surprise. He had never made a secret of his disdain for the
French and their way of doing things—the constant intrigue and infighting, the chronic instability of governments, the overweening role of the state. During 1924, and especially 1925 after Britain had gone back to the gold standard, he had indulged in a certain schadenfreude at France’s financial travails. As the franc plunged, he confessed to Strong that the position of France, held up since the war as an example of the advantages of unorthodox financial management, made him “smile
⁴³⁹
.”

Moreau, for his part, reciprocated the enmity. From his very first few days in office, he had been irritated by the presumption of Anglo-Saxon bankers that the French would be unable to stabilize the franc without their help. Much of his animosity was specifically directed against Norman, a reflection of a wider and more pervasive suspicion toward the governor of the Bank of England throughout Europe, except in Germany. Strong had picked up on it in the summer of 1926, noting that Continental financial officials “seem to be afraid of him
⁴⁴⁰
and somewhat distrust him.”

With the Banque flush with hard currency and the franc stable, Moreau was determined to use his newfound independence to reestablish French financial prestige. He had not forgotten that before the war Paris had been the second most important money center in the world.

His first opportunity to assert himself on the international stage came in connection with a loan to Poland, which had regained its independence after the war and was historically seen as a partner of France in containing German power. In late 1926, a consortium of central banks, including the Federal Reserve, the Bank of England, the Reichsbank, and now the Banque de France, put together a financial package to help stabilize the Polish zloty. When Norman tried to grab the lead role, the French objected strongly to what they saw as a British attempt to muscle in on France’s traditional sphere of influence in Eastern Europe. For Moreau it was one more example of Norman’s “imperialist dreams
⁴⁴¹
.”

In February 1927, the Banque also tried to renegotiate terms on a loan from the Bank of England dating back to 1916 and secured by French gold. As usual when it came to the French, Norman was unhelpful, putting numerous obstacles in the way. Frustrated by Norman’s obstructionism, the
Banque surprised the Bank of England in May by announcing that it would pay off the loan and take back the $90 million of gold reserves pledged as security. The next month, without even consulting the British, the Banque issued instructions that $100 million of its sterling balances be converted into gold. The effect would have been to drain almost $200 million of gold out of the Bank of England’s reserves. Both actions came as a shock to Norman. Moreau’s demands were “capricious
⁴⁴²
” and would “menace the gold standard,” he complained to Strong.

Norman and Moreau met repeatedly during the first few months of 1927—in Paris in February, in London in March, and at the Terminus Hotel in Calais in early April—to try to resolve some of these issues. Though the tensions between them never quite broke into open conflict—they were careful to maintain a frosty politeness in all their dealings—their mutual dislike and mistrust were apparent. Moreau had clearly not forgotten how unwilling Norman had been to come to the aid of France at the height of the previous year’s crisis, a sharp contrast to the way the Englishman had bent over backward to help Schacht and the Germans in 1924.

The gold standard did offer a traditional safety valve for dealing with shifts in gold holdings. The shrinkage of reserves in the country losing bullion was supposed to lead to an automatic contraction in credit and a rise in interest rates, which would thereby shrink its buying power, while attracting money from abroad. Meanwhile, the country gaining gold would find its credit expanding and its capacity to spend increasing. These “rules of the game,” as Keynes called them, were designed to set in train automatic gyroscopic forces to balance out the shifting tides of gold among countries.

But in early 1927, the Bank of England and the Banque de France could not agree how to apply these rules. A conference was arranged and on May 27, Norman revisited the Banque. It was a very different meeting from that first disastrous encounter a year earlier. Now it was Norman’s turn to plead for help. He claimed that it would be politically impossible to tighten credit in Britain, that “he could not do so
⁴⁴³
without provoking a riot.” Arguing that most of the money flowing into France came from speculators
betting that the franc would have to appreciate, he pressed Moreau to cut interest rates.
^fn3

Moreau, on the other hand, had just weathered a decade of high inflation, which he did not wish to risk repeating by easing credit. He insisted that under the rules of the gold standard, he had the complete right to convert his sterling holdings into bullion, and should this put Britain’s reserves under pressure, the Bank of England could always raise rates.

Quite aware that too precipitate an action by the Banque de France would threaten the Bank’s ability to keep the pound on gold, he tried to reassure Norman that he had no intention of destabilizing the gold standard or trying to undermine sterling, declaring melodramatically, “I do not want to trample
⁴⁴⁴
on the pound.” Both parties claimed to be committed to the game, but each was adamant that it was the other who was not following the rules.

The British were not completely on the defensive. They did point out that while France held some $350 million in sterling that it could convert into gold, the British government held $3 billion of French war debts on which it could theoretically demand immediate repayment. The meeting closed in an inconclusive truce. In the following weeks, both sides somewhat halfheartedly backed down, the Bank of England allowing rates in Britain to rise modestly and the Banque de France engineering a fall in its rates. For the moment, outright financial conflict had been averted.

^fn1
In this book I have chosen to use the Dow Jones Industrial Average as a measure of the average level of the stock market, for all its many deficiencies, the oldest and best known stock average. Introduced by the founder of the
Wall Street Journal,
Charles Dow, in 1896, it then comprised the average of twelve industrial stocks. The list was expanded to twenty in 1916 and to thirty in 1928. The only index of comparable repute is the S&P, but that was not introduced until 1923 and remained relatively obscure until after the war.

^fn2
By comparison, during the great boom years from 1890 to 1910, it oscillated between 15 and 20. In 1929, it reached a peak of 32; at the height of the Internet bubble, it soared to 45.

^fn3
He also argued that while the franc had been stabilized de facto but not de jure at 25 francs to the dollar, speculators could still harbor the hope that the franc would eventually be fixed at a higher exchange rate, providing those who held francs with windfall gains. Norman insisted that the only way to combat this form of destabilizing speculation was for the French government to fix its rate de jure. It finally did so in June 1928.

Not every mistake is a foolish one.

—C
ICERO

BY THE END
of 1926, this quartet of central bankers had already begun to worry about three of the factors—the U.S. stock market bubble, excessive foreign borrowing by Germany, and an increasingly dysfunctional gold standard—that would eventually lead to the economic upheaval at the end of the decade. None of them, however, yet anticipated the scale of the coming storm. Hjalmar Schacht was locked in combat with his own government; Montagu Norman and Émile Moreau were squabbling with each other; and Benjamin Strong was, as always, battling on two fronts—with his health and with his colleagues within the Federal Reserve System.

In 1926, after almost two years without an attack of tuberculosis, Strong developed pneumonia on his return from his summer in Europe. While lying sick with the new disease, at one point close to death, he was again scarred by personal tragedy, this one carrying with it a hint of scandal.

Confined to the Cragmore Sanatorium at Colorado Springs in 1923, he had struck up a friendship with another tubercular patient, Dorothy Smoller, a twenty-two-year-old actress from Tennessee. She had once been a dancer with Anna Pavlova’s ballet company, had had several parts on
Broadway, and had even had a bit part in a movie. After a few months in the sanatorium, her money had run out and Strong and some other rich patients stepped in to support her. In November 1926, she resurfaced in New York, to be treated by Dr. James Miller, a Park Avenue physician and Strong’s personal doctor—like most tuberculosis patients, she had not fully shaken off the disease. She had just landed a part
⁴⁴⁵
in another Broadway play when on the morning of December 9, after receiving a mysterious letter that reportedly distressed her, she killed herself by drinking a bottle of liquid shoe polish.

By her bedside were three letters, one for her mother in Long Beach, California, one for a friend, and one for Strong. She left instructions that the photograph of Strong in her possession be returned to him. No one can know whether she and Strong were romantically involved. Perhaps she was just a lost and unhappy young woman, a victim of the Broadway version of the boulevard of broken dreams, who had developed a fixation upon a distinguished and kindly man who had helped her. Whatever the case, her suicide, with its echoes of his wife’s death twenty years earlier, must have shaken him profoundly.

In December, he again left New York to recuperate, for a few weeks at the Broadmoor Hotel in Colorado Springs and thereafter in North Carolina. He returned to work six months later, in May 1927, to find the strains and stresses within Europe again building. The quarrel between Moreau and Norman was threatening to derail the pound, and had the potential to undermine the stability of the entire structure of the worldwide gold standard. Meanwhile, Schacht was beginning to clamor for some sort of international initiative to control the flow of foreign money into Germany, which, he feared, would never be able to repay all of its various accumulating debts.