America's Great Depression (29 page)

Britain’s immediate problem stemmed directly from her insistence on continuing cheap money. The Bank of England had lowered its discount rate from 5 percent to 42 percent in April, 1927, in a vain attempt to stimulate British industry.30 This further weakened the pound sterling, and Britain lost $11 million in gold during 29See Benjamin M. Anderson,
Economics and the Public Welfare
(New York: D.

Van Nostrand, 1949), p. 167.

30During the fall of 1925, Norman had similarly reduced Bank Rate. At that time, Strong had been critical, and was also led by the American boom to raise discount rates at home. By December, Britain’s Bank Rate was raised again to its previous level.

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the next two months, and the Bank of France, in a strong creditor position, tried to redeem its sterling in gold.31 Instead of tightening credit and raising interest rates sharply to meet this gold drain, as canons of sound monetary policy dictated, Great Britain turned to its old partner in inflation, the Federal Reserve System. The stage was clearly set once more, according to the logic of the American and British money managers, for another great dose of credit expansion in the United States.

Accordingly, Governor Montagu Norman, the Mephistopheles of the inflation of the 1920s, conferred with Strong and Moreau, of the Bank of France, in Paris. He tried a variety of pressures during 1927 to dissuade the Bank of France from selling its sterling balances for gold—balances which, after all, were of little use to the French.32 Norman also tried to induce the French to do some inflating themselves, but Moreau was not a Benjamin Strong.

Instead, he not only remained adamant, but urged Norman to allow Britain’s loss of gold to tighten credit and raise interest rates in London (thus checking British purchase of francs). But Norman was committed to a cheap money policy.

Strong, on the contrary, leaped to Britain’s aid. Trying to bolster sterling, he used American gold to ease the gold premium in Britain and also purchased some sterling bills to aid his ally. And, furthermore, Strong and Norman organized the famous inter-central bank conference at New York, in July, 1927. The conference was held
in camera
, and included Norman, Strong, and representatives from the Bank of France and the German Reichsbank: Deputy Governor Charles Rist, and Dr. Schacht respectively.

Strong ran the American side with an iron hand, and even refused to permit Mr. Gates McGarrah, Chairman of the Board of the Federal Reserve Bank of New York, to attend the meeting. The Federal Reserve Board in Washington was left in the dark, and was 31Much of its sterling balances were accumulated as the result of a heavy British credit expansion in 1926.

32The Bank of France had acquired these balances in a struggle to stabilize the franc at too
low
a rate, but without yet declaring gold convertibility. The latter step was finally taken in June, 1928.

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155

allowed only a brief courtesy call from the distinguished guests.

The conference was held at the Long Island estates of Undersecretary of the Treasury Ogden Mills and of Mrs. Ruth Pratt of the wealthy Standard Oil family.

Norman and Strong tried mightily to induce Rist and Schacht to go along with a general four-country inflation, but the latter two vigorously declined. Schacht continued his determined opposition to inflation and artificially cheap money, and expressed his alarm at the inflationary trend. Rist demurred also, and both Rist and Schacht left for home. Rist agreed, however, to buy gold from New York instead of London, thus easing the pressure on England to redeem its obligations. The New York Reserve Bank, in turn, agreed to supply France with gold at a subsidized rate: as cheap as the cost of buying it from England, despite the higher transport costs.

Remaining to weld their inflationary pact, Norman and Strong agreed to embark on a mighty inflationary push in the United States, lowering interest rates and expanding credit—an agreement which Rist maintains was concluded before the four-power conference had even begun. Strong had gaily told Rist that he was going to give “a little
coup de whiskey
to the stock market.”33 Strong also agreed to buy $60 million more of sterling from the Bank of England.

The British press was delighted with this fruit of the fast Norman–Strong friendship, and flattered Strong fulsomely. As early as mid-1926, the influential London journal,
The Banker,
had said of Strong that “no better friend of England” existed, had praised the

“energy and skillfullness that he has given to the service of England,” and had exulted that “his name should be associated with that of Mr. [Walter Hines] Page as a friend of England in her greatest need.”34

33Rist, “Notice Biographique,” pp. 1006ff.

34See Clark,
Central Banking Under The Federal Reserve System,
p. 315. Paul Warburg’s tribute to Strong was even more lavish. Warburg heralded Strong as the pathfinder and pioneer in “welding the central banks together into an intimate group.” He concluded that “the members of the American Acceptance Council
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America’s Great Depression

In response to the agreement, the Federal Reserve promptly launched a great burst of inflation and cheap credit in the latter half of 1927. Table 8 shows that the rate of increase of bank reserves was the greatest of the 1920s, largely because of open-market purchases of government securities and of bankers’ acceptances. Rediscount rates were also lowered. The Federal Reserve Bank of Chicago, not under the domination of the Bank of England, balked vigorously at lowering its rate, but was forced to do so in September by the Federal Reserve Board. The
Chicago Tribune
called angrily for Strong’s resignation, and charged that discount rates were being lowered in the interests of Great Britain. The regional Reserve Banks were told by Strong that the new burst of cheap money was designed to help the farmers rather than England, and this was the reason proclaimed by the first bank to lower its discount rate—not New York but Kansas City. The Kansas City Bank had been picked by Strong as the “stalking-horse” of the new policy, in order to give as “American” a flavor as possible to the entire proceeding. Governor Bailey of the Kansas City Bank had no inkling of the aid-to-Britain motive behind the new policy, and Strong took no pains to enlighten him.35

Perhaps the sharpest critic of the inflationary policies within the Coolidge administration was Secretary Hoover, who privately did his best to check the inflation from 1924 on, even going so far as to denounce Strong as a “mental annex to Europe.” Hoover was overruled by Strong, Coolidge, and Mellon, with Mellon denouncing Hoover’s “alarmism” and interference. Mellon was Strong’s staunchest supporter in the administration throughout would cherish his memory.” Paul M. Warburg,
The Federal Reserve System
(New York: Macmillan, 1930), vol. 2, p. 870.

In the autumn of 1926, a leading banker admitted that bad consequences would follow the cheap money policy, but said: “that cannot be helped. It is the price we must pay for helping Europe.” H. Parker Willis, “The Failure of the Federal Reserve,”
North American Review
(1929): 553.

35See Anderson,
Economics and the Public Welfare,
pp. 182–83; Beckhart,

“Federal Reserve Policy and the Money Market,” pp. 67ff.; and Clark,
Central
Banking Under the Federal Reserve System,
p. 314.

The Development of the Inflation

157

the entire period. Unfortunately for later events, Hoover—like most of Strong’s academic critics—attacked only
stock-market
credit expansion rather than expansion
per se
.

The reasons for Strong’s devious and secret methods, as well as the motives for his inflationary policies, have been no better described than in a private memorandum by one of Strong’s staff.

In the spring of 1928, Strong firmly rejected the idea of an open, formal conference of world central banks, and, in the words of his assistant:

He [Strong] was obliged to consider the viewpoint of the American public, which had decided to keep the country out of the League of Nations to avoid interferences by other nations in its domestic affairs, and which would be just as opposed to having the heads of its central banking system attend some conference or organization of the world banks of issue. . . . To illustrate how dangerous the position might become in the future as a result of the decisions reached at the present time and how inflamed public or political opinion might easily become when the results of past decisions become evident, Governor Strong cited the outcry against the speculative excesses now being indulged in on the New York market. . . . He said that very few people indeed realized that we were now paying the penalty for the decision which was reached early in 1924 to help the rest of the world back to a sound financial and monetary basis.36

In short, in our supposed democracy, if the people were allowed to know what had been transacted in their name and what penalties they were subsequently being forced to pay, they would rise up in their wrath. Better to keep the people in ignorance. This, of course, is the familiar attitude of the bureaucrat in power. But what of the fundamental question it raises for democracy itself: how can the people decide upon issues or judge their presumed representatives, if the latter insist on keeping vital information from them?

Strong himself, furthermore, did not realize how heavy a penalty the American public would be forced to pay in 1929. He 36O. Ernest Moore to Sir Arthur Salter, May 25, 1928. Quoted in Chandler,
Benjamin Strong, Central Banker,
pp. 280–81.

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died before the crisis came. If the public had at last been let in on the truth of Strong’s actions and their consequences, perhaps, during the depression, they would have become “inflamed” against inflationary government intervention rather than against the capitalist system.

After generating the 1927 inflation, the New York Federal Reserve Bank, for the next two years, bought heavily in prime commercial bills of foreign countries, bills endorsed by foreign central banks. The purpose was to bolster foreign currencies, and to prevent an inflow of gold to the United States. The New York Bank frankly described its policy as follows: We sought to support exchanges by our purchases and thereby not only prevent the withdrawal of further amounts of gold from Europe but also, by improving the position of the foreign exchanges, to enhance or stabilize Europe’s power to buy our exports.

Those decisions were taken by the New York Reserve Bank alone, and the foreign bills were then distributed
pro rata
to the other Reserve Banks.37

While the New York Reserve Bank was the main generator of inflation and cheap credit, the Treasury also did its part. As early as March 1927, Secretary Mellon assured everyone that “an abundant supply of easy money” was available—and in January 1928, the Treasury announced that it would refund a 43 percent Liberty Bond issue, falling due in September, into 32 percent notes.38

Again, the inflationary policy was temporarily successful in achieving its goals. Sterling was strengthened, the American gold inflow was sharply reversed and gold flowed outward. Farm product prices rose from 99 in 1927 to 106 the following year. Farm and food exports spurted upward, and foreign loans were stimulated to 37Clark,
Central Banking Under the Federal Reserve System,
p. 198. We have seen that sterling bills were bought in considerable amount in 1927 and 1929.

38See Harold L. Reed,
Federal Reserve Policy, 1921–1930
(New York: McGraw–Hill, 1930), p. 32.

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159

new heights, reaching a peak in mid-1928.39 But by the summer of 1928, the pound sterling was sagging again. American farm prices fell slightly in 1929, and the value of agricultural exports also fell in the same year. Foreign lending slumped badly as both domestic and foreign funds poured into the booming American stock market. The higher interest rates caused by the boom could no longer be lower than in Europe, unless the FRS was prepared to continue inflating, perhaps at an accelerated rate. Instead, as we shall see below, it tried to curb the boom. As a result, funds were attracted to the United States, and by mid-1928, gold began to flow in again from abroad. And, by this time, England was back in its familiar mess, but now more aggravated than before.

THE CRISIS APPROACHES

By now, the final phase of the great American boom was under way, led by the stock market. While a stock market loan is no more inflationary than any other type of business loan, it is equally inflationary, and therefore credit expansion in the stock market deserves censure in precisely the same way, and to the same extent, as any other quantity of inflated credit. Hence, the mischievous inflationary effect of the 1927 statements by Coolidge and Mellon who functioned as the “capeadores” of the bull market. We have also seen that the Federal Reserve Bank of New York effectively set the call rates for loans to the stock market, in cooperation with the money committee of the New York Stock Exchange, its policy being to furnish any funds necessary to enable the banks to lend readily to the market. The Bank, in short, used Wall Street banks to pour funds into the stock market. The call rate, as we have noted, stayed very far below its prewar levels and peaks.

Alarmed at the burgeoning boom, and at the stock prices that rose about 20 percent in the latter half of 1927, the Fed reversed 39Clark points out that the cheap credit particularly succeeded in aiding the financial, investment banking, and speculative interests with whom Strong and his associates were personally affiliated. Clark,
Central Banking Under the Federal
Reserve System,
p. 344.

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its policy in the spring of 1928, and tried to halt the boom. From the end of December 1927, to the end of July 1928, the Reserve reduced total reserves by $261 million. Through the end of June, total demand deposits of all banks fell by $471 million. However, the banks managed to shift to time deposits and even to overcom-pensate, raising time deposits by $1.15 billion. As a result, the money supply still rose by $1.51 billion in the first half of 1928, but this was a relatively moderate rise. (This was a rise of 4.4 percent per annum, compared to an increase of 8.1 percent per annum in the last half of 1927, when the money supply rose by $2.70 billion.) A more stringent contraction by the Federal Reserve—one enforced, for example, by a “penalty” discount rate on Reserve loans to banks—would have ended the boom and led to a far milder depression than the one we finally attained. In fact, only in May did the contraction of reserves take hold, for until then the reduction in Federal Reserve credit was only barely sufficient to overcome the seasonal return of money from circulation. Thus, Federal Reserve restrictions only curtailed the boom from May through July.