Lords of Finance: 1929, the Great Depression, and the Bankers Who Broke the World (62 page)

A telegram was dispatched to Norman, then in mid-Atlantic aboard the HMS
Duchess of Bedford
, on his way home from Canada but still two days from shore. He had not taken his codebook and the radio message
had to be sent on an open line. There is a wonderful but apocryphal story that to disguise the message, the deputy governor wrote, “Old Lady goes off on Monday.” Puzzled by this cryptic note, Norman assumed that it referred to his mother’s plans to go on holiday and thought nothing further of it.

The real story is almost as good. The cable in fact read, “Sorry we have to go off tomorrow and cannot wait to see you before doing so.” Norman assumed that it meant Harvey was going to be away on the day of his return to Britain. He only discovered the truth when he landed at Liverpool on Wednesday, September 23. After meeting with the prime minister, he departed for a long weekend in the country to get over the shock. As his friend Baldwin put it indelicately, “Going off the gold standard
⁶⁹²
was for him as though a daughter should lose her virginity.” But, for all his anger, it is hard to see what he would or could have done differently had he been around.

The initial public reaction that week was one of alarm and astonishment. Few people understood what it meant. Most newspapers lamented it as the end of an epoch. Only the
Daily Express,
organ of that clear-sighted financial adventurer Lord Beaverbrook, called it a victory for common sense. “Nothing more heartening has happened
⁶⁹³
in years . . . we are rid of the gold standard, rid of it for good and all, and the end of the gold standard is the beginning of real recovery in trade,” he beamed.

The
Sunday Chronicle
of September 20 carried a profile of Montagu Norman by Winston Churchill, as part of a commissioned series on contemporary figures. Since leaving office in June 1929, Churchill had quarreled with his Conservative colleagues over Indian self-rule and, now isolated and out of favor, felt free to express his disillusionment with the gold standard orthodoxy openly. The problem was not so much the standard itself, he argued, but the way it had been allowed to operate. It was the hoarding of gold by the United States and France and the resulting shortage in the rest of the world that had brought on the Depression. He had begun to sound almost like Keynes—in a speech to Parliament the week before he had described how gold “is dug up out of a hole in Africa
⁶⁹⁴
and put down in another hole that is even more inaccessible in Europe and America.”

That weekend Churchill had the star of
The Gold Rush
, Charlie Chaplin, as a guest at Chartwell
⁶⁹⁵
, his country house in Kent—they had met in Hollywood when Churchill was visiting the United States in October 1929 at the time of the crash. Over dinner Chaplin opened the conversation by saying, “You made a great mistake when you went back to the gold standard at the wrong parity of exchange in 1925.” Churchill was somewhat taken aback. As the film star proceeded to hold forth at length about the subject with a great deal of knowledge, Churchill, who hated to be reminded of past mistakes, sank into a morose silence, a mood broken only when the comedian picked up two rolls of bread, put two forks in them and did the famous dance from the movie.

The next day, Monday, September 21, the first day off gold, by an odd quirk of fate, Churchill lunched with Maynard Keynes, now an ally and friend. Churchill spent much of the time protesting that he had never been in favor of returning to gold in 1925 and been overridden by Norman and the rest of the City. For Keynes it was a day of celebration and not regret. He could hardly contain his glee, “chuckling like a boy
⁶⁹⁶
who has just exploded a firework under someone he doesn’t like.” “There are few Englishmen who do not rejoice
⁶⁹⁷
at the breaking of the gold fetters,” he wrote in an article later that week. “We feel that we have at last a free hand to do what is sensible. . . . I believe that the great events of the last week will open a new chapter in the world’s monetary history.”

But among bankers, especially European bankers, the British departure from gold was seen as an utterly dishonorable step, a “tragic act of abdication
⁶⁹⁸
” that “inflicted heavy losses on all those who had trusted” the word of the Bank of England. Within a few days the pound had fallen by almost 25 percent in the foreign exchange markets from $4.86 to $3.75. By December it was a little below $3.50, a drop of 30 percent. Altogether twenty-five countries followed Britain off gold during the next few months, not only the nations of the empire and its satellites Canada, India, Malaya, Palestine, and Egypt, but also the Scandinavians—Sweden, Denmark, Norway,
and Finland—and finally those European countries with close commercial ties to Britain: Ireland, Austria, and Portugal.

Though the papers kept telling him that it was the end of an era, for the average Englishman, after a few days of stunned confusion, it was as if nothing had happened. There were no bank runs, no food shortages, no rush to the stores, no hoarding of goods. Indeed, while wholesale prices in the rest of the world would continue to fall, dropping 10 percent over the next year, in Britain deflation came to an end—prices over the next year even rose a modest 2 percent.

The one group who received a big shock was the small number of British people traveling abroad.
Time
magazine recounted how one man in an Old Etonian tie was sufficiently incensed at being offered only $3 for his pounds in New York—a “hold-up,” he called it—that he stormed off muttering, “A pound is still a pound
⁶⁹⁹
in England. I shall carry my pounds home with me.”

The recriminations began almost immediately. Snowden in his speech to the Commons on September 20 blamed the debacle on the gold policies of the United States and France. Though Americans came in for their fair share, the greatest vituperation was reserved for the French. Margot Asquith, in a letter to Norman wishing him well on his return, captured the country’s mood when she wrote, “France will be heavily punished
⁷⁰⁰
for her selfish short-sightedness. She has been the curse of Europe. . . .” Ironically, the one institution upon which the devaluation wrought disaster was the Banque de France. For years an urban myth insisted that it had been French selling of the pound that had set off the debacle. In fact, the Banque had hung on to every penny of its $350 million in sterling deposits. So supportive had it been during the crisis that Clément Moret was later named an honorary Knight Commander in the Order of the British Empire. The Banque de France ended up losing close to $125 million, seven times its equity capital. A normal bank would have been driven under.

Other central banks, especially those of Sweden, the Netherlands, and Belgium, that had been persuaded during the 1920s to keep part of their reserves in sterling lost enormous amounts. The Dutch central bank lost
all its capital—the bitterness ran particularly deep because a few days before the devaluation, its governor, forgetting that only simpletons ask a central banker about the value of his currency and expect an honest answer, had inquired whether his deposits were safe and had been unequivocally reassured. Norman was so embarrassed by the losses sustained by his fellow central bankers that he contemplated submitting a letter of resignation to the BIS. It would have been a quaintly anachronistic gesture—like an ashamed bankrupt resigning from his club—but he was persuaded that it would be impractical for the institution to operate without a Bank of England presence at its meetings.

NO ONE HAD
done more to prop up Europe that summer than George Harrison. It must have seemed to him at times that he had spent most of the summer on transatlantic telephone calls—at the height of the Central European crisis he and Norman must have spoken on the phone, not a simple matter in those days, more than twenty-five times. After the first Austrian loan back in May, when few could have foreseen how far the panic would go, the Fed had provided the Reichsbank with $25 million, been ready to throw in a mammoth $500 million for the second loan that never got off the ground, supplied a further $250 million to the Bank of England, and, finally, been instrumental in orchestrating the last $200 million loan from the Morgan consortium to the British government. It had all been to no effect. Europe’s problems had proved to be much deeper, and its needs far larger, than the Fed was capable of handling.

After Britain left the gold standard, the financial crisis now spread across the Atlantic. Over the next five weeks, Europeans, fearing that the United States would be next to devalue, converted a massive $750 million of dollar holdings into gold. While some popular accounts attributed the outflow of gold to “panicky millionaires” and speculators hoping to make a buck from such a collapse, it was not private investors who were principally behind the flow but European central banks, the largest single mover of capital being the staid and upright Swiss National Bank, which
transferred close to $200 million. The National Bank of Belgium moved $130 million; the already badly burned Netherlands Bank, $77 million; and the Banque de France, $100 million. Having lost its capital seven times over during the sterling devaluation out of a misplaced sense of “solidarity and politeness
⁷⁰¹
”—Governor Moret’s words—and having been rewarded with a campaign of public vilification in Britain, the Banque de France had learned its lesson. The cost of being a responsible global citizen was just too great.

The outflow of gold came at a particularly crucial juncture for the U.S. banking system, then reeling under the wave of failures that had begun in the spring in Chicago. By September, the panic had swept Ohio and was circling back to Pittsburgh and Philadelphia. A committee of prominent Philadelphians, including the president of the University of Pennsylvania, the cardinal archbishop, and the mayor, published an appeal in the newspapers urging faith in local banks. To no avail—39 banks in the city with over $100 million in deposits were forced to close down. In one month alone after the British departure from gold, 522 American banks went under—by the end of the year, a total of 2,294, one out of every ten in the country, with a total of $1.7 billion in deposits, would suspend operations.

The mounting bank failures intensified hoarding—$500 million in cash was pulled from banks. While most of this was stashed away in traditional hiding places—socks, desks, safes, strongboxes under the bed, deposit vaults—some found its way to very unconventional spots, including, according to a congressional report, “holes in the ground, privies
⁷⁰²
, linings of coats, horse collars, coal piles, hollow trees.” Anywhere but bank accounts.

The Fed had begun 1931 with a massive $4.7 billion in gold reserves. Even after the fall outflow, it had more than enough bullion and was never at any risk of being stripped bare as the Bank of England or the Reichsbank had been. Nevertheless, because of a strange technical anomaly in its governing laws, it found itself facing an artificial squeeze on its reserves.

By statute, every $100 in Federal Reserve notes had to be backed by at
least $40 in gold, the remaining $60 by so-called eligible paper—that is, prime commercial bills used to finance trade. Even though the Federal Reserve banks were permitted to hold government securities, and the buying and selling of such securities—open market operations—was one of the mechanisms by which the Fed injected money into the system, government paper could not be employed as an asset to back currency. Even when first introduced in the original 1913 legislation setting up the Fed, the restriction had been redundant, since the 40 percent gold requirement was enough to prevent the central bank from being used as an instrument of inflation. By 1931, with no risk of inflation—the country in fact facing a problem of deflation—the restriction served no purpose. Nevertheless, it remained obstinately on the books.

With the Depression and the ensuing stagnation in trade, prime bills were scarce and hard to find. The Fed had to rely on gold to back its currency. Thus, in the fall of 1931, instead of having $2 billion too much gold and being grateful that some of it was finally flowing back to Europe, it found itself scrambling to hold on to its reserves. It was a manufactured problem, the result of an anachronistic regulation that had no basis in economic reality but which tied up a large amount of U.S. gold unnecessarily.

And so early that October, in the midst of the Depression, as bank runs raged across the Midwest, thousands of businesses closed down, and industrial production contracted at an annualized rate of 25 percent, the Fed raised interest rates from 1.5 percent to 3.5 percent. With prices falling by 7 percent a year, this put the effective cost of money above 10 percent. So dominant was the view that abiding by these reserve requirements trumped every other consideration, there was no internal resistance at the Fed to jacking up the cost of credit. Even the two principal expansionists, Meyer and Harrison, went along.

The president still continued to cling to the notion that private sector initiatives were the best way to revive the economy. On the evening of Sunday, October 4, he secretly slipped out of the White House and made his way to Mellon’s apartment at 1785 Massachusetts Avenue, where Harrison of the New York Fed had assembled a group of nineteen New York
bankers, among them Thomas Lamont and George Whitney of J. P. Morgan & Co., Albert Wiggin of Chase National, William Potter of Guaranty Trust, and Charlie Mitchell of National City—in short, the usual suspects. Amid the Rubenses and Rembrandts, which Mellon had so assiduously collected, the president outlined a plan to try to break the vicious cycle whereby people were pulling cash out of banks and banks were having to cut credit.

Banks were going under in part because the assets they held on their books could not be used as collateral to borrow from the Fed. By the fall of 1931, the neat distinction between liquidity and solvency on which the Fed, following Bagehot, had placed so much emphasis, was becoming meaningless. Many banks experiencing withdrawals would have been fine under normal circumstance, but forced to call in loans and liquidate assets in a falling market at fire-sale prices, they were being driven into insolvency. Hoover proposed that a new fund of $500 million be created by the larger and stronger private banks to lend to smaller banks on collateral that the Federal Reserve was legally unable to accept.