Lords of Finance: 1929, the Great Depression, and the Bankers Who Broke the World (68 page)

Every morning at nine o’clock, Morgenthau; Jesse Jones, the head of the RFC; and George Warren would meet with the president over his breakfast of soft-boiled eggs, to determine the price of gold for that day. They began at $31.36 an ounce. The next morning this increased to $31.54, then $31.76 and $31.82. No one had a clue how they went about setting the price, although everyone presumed that some subtle analyses of the world bullion and foreign exchange markets went into their calculations. In fact, the choice of price was completely random. All they were trying to do was push the price a little higher than the day before. The exercise brought out the juvenile in Roosevelt. One day he picked an increase of 21 cents, and when asked why, replied that it was a lucky number, three times seven.

Everyone wanted to know more about the mysterious “crack-brained” economist
⁷⁴⁶
of whose theories Roosevelt had become so enamored. Much to the dismay of the publicity-shy Warren, his face appeared on the cover of
Time
magazine. Reporters finally managed to track down the elusive professor who had taken leave from Cornell; he was living at the Cosmos Club in Washington and worked from an office in the Commerce Building with an unlisted phone number. There were no files in the office—he carried all his research in his briefcase and slipped in and out of the White House through one of the side entrances. Anyone knocking at the door would be greeted with a cry, “Not in!”

As the bridge between the government and the markets, it was Harrison at the New York Fed who actually had to buy the gold. Here was a man trained to believe that nothing was more sacrosanct than the value of the currency, a protégé of one of the key architects of the postwar gold standard, being asked to weaken the dollar as an act of policy. It was, as one journalist put it, “like asking a sworn teetotaler
⁷⁴⁷
to swallow a bottle of gin.”

Harrison was by nature a diplomat. With Wall Street mocking the
president for allowing currency policy to fall into the hands of an expert on chickenfeed, it required all his tact and diplomatic skills to act as the intermediary between the bankers and a White House that was breaking every monetary convention in the rule book. When Harrison first informed Norman of the new policy, the British central banker “hit the ceiling
⁷⁴⁸
.” “This is the most terrible thing
⁷⁴⁹
that has happened. The whole world will be put into bankruptcy,” he exclaimed. Roosevelt and Morgenthau both roared with laughter at the thought of “old pink whiskers”—Roosevelt’s nickname for Norman—and the other “foreign bankers, with everyone of their hairs standing on end with horror.”

During November and December 1933, Harrison and the president would talk on the telephone several times a week, sometimes several times a day. Though Harrison thought that Warren’s ideas were complete bunkum, he gradually found himself succumbing to Roosevelt’s seductive charm, even becoming an honorary associate member of the president’s circle. And so while all the other hard-currency men who had come in with the new administration—Warburg, Sprague, Acheson, Moley—resigned or were fired, Harrison hung in there, convinced that if he went, Roosevelt might come up with some even more harebrained scheme; or even worse, that Congress would get into the act. And he feared the inflationists in Congress more than Roosevelt’s predilection for wacky ideas.

THE THREE-MONTH
interlude in which Roosevelt spent his breakfast hours managing the world’s gold price represents one of the more bizarre episodes in the history of currency policy. It undermined the dignity of the office of president and diminished respect for him abroad. Even Maynard Keynes, who was in favor of managed currencies, dismissed the exercise as “the gold standard on the booze
⁷⁵⁰
.” But at least the dollar staggered in the right direction.

By the end of the year, Roosevelt had begun to tire of the game; and in January 1934 he agreed to stabilize gold at $35 to the ounce. The dollar had now been devalued by over 40 percent. And while the high priests of Wall
Street had prophesied chaos, Roosevelt’s instincts were vindicated. Devaluation changed the whole dynamic of the economy.

This worked in two ways. First, as Warren had predicted, the fall in the dollar did get prices moving upward—by roughly 10 percent per annum. Once prices began rising, the burden of interest payments and the real cost of money were automatically reduced, making businesses more willing to borrow and consumers more ready to spend. By thus shaking the country out of its funk, the dollar move reversed expectations out of their vicious and self-fulfilling downward spiral into a virtuous circle pointing the other way. For as the economy developed momentum, the recovery fed on itself.

Devaluation not only changed the dynamic of spending, it also supplied the fuel to power those expenditures. In the four years after 1933, the value of gold
⁷⁵¹
held by the Fed almost tripled, to $12 billion, in part due to the higher value of the existing stock of gold, in part to new inflows of gold from abroad—over $5 billion of additional bullion arrived in the country. Some of this was drawn from other central banks. But most came from the ground, as the higher price spurred the mining industry—worldwide gold production added almost $1 billion a year to world reserves. A high fraction of this additional liquidity went into building up the reserves of banks, which, scarred by the years from 1931 to 1933, took a long time to regain their nerve. Nevertheless, there was enough money flooding through the system that it percolated through to the rest of the economy.

As a consequence, during Roosevelt’s first term, U.S. industrial production doubled and GDP expanded by 40 percent—the largest peacetime increase in economic activity in a presidential term. The expansion did not occur in a straight line and was not uniform. Confidence was still fragile and recovery thus subject to fits and starts. Investment did not rebound as much as consumption—for many of the New Deal policies to support wages hurt both profits and general business confidence. The economic indicator, which took the longest to recover, was employment. Even while production doubled in four years, the number of unemployed remained stubbornly high—by 1936, there were still ten million men without jobs.
Again, many of Roosevelt’s measures to boost prices or wages by government fiat raised the cost of hiring workers and hampered recovery. Because the contraction had gone so deep, it still took ten years for the economy to regain its old trend.

While the rebound was powered by an abundance of money at low interest rates, the Fed found itself ejected from the driving seat. Having made such a mess during the collapse, it had lost whatever prestige it once possessed.

In 1935, Congress passed a banking act designed to reform the Federal Reserve. Authority for all major decisions was now centralized in a restructured Board of Governors. The regional reserve banks were stripped of much of their powers and responsibility for open market operations was now vested in a new committee of twelve, comprising the seven governors and a rotating group of five regional bank heads, renamed presidents. The secretary of the treasury and the comptroller of the currency were removed from the Board, giving it theoretically even greater independence from an administration. While these measures improved the efficiency of the Fed’s decision-making machinery, they came ironically enough at a time when there were few decisions to take. In 1934, Marriner Eccles, a Mormon banker from Utah, had taken over as the head of the Federal Reserve Board. Scarred by the experiences of running a bank during the Great Depression, Eccles held to the view that with unemployment still high and confidence still weak, the Fed’s prime task should be to keep interest rates as low as possible.

Though the New York Fed lost much of its clout and was now overshadowed by the Board in Washington, George Harrison soldiered on as its president for another eight years. In 1941, he left to become the chief executive of the New York Life Insurance Company. During World War II, he was asked by his old friend Henry Stimson, now secretary of war, to become his special assistant for matters related to the Manhattan Project. He served on the Interim Committee, a secret high-level group formed in May 1945 to examine problems related to the creation of the atomic bomb and to advise on its use against Japan. On July 16, after the successful
detonation of the world’s first nuclear device in the New Mexico desert, it was Harrison who was the author of the now-famous cable to Secretary Stimson and President Truman at Potsdam: “Operated on this morning
⁷⁵²
. Diagnosis is not complete but results seem satisfactory and already exceed expectations.”

After the war he returned to the New York Life Company. Like so many central bankers, he married late—at the age of fifty-three—to Mrs. Alice Grayson, widow of his old friend Admiral Grayson, who had been Woodrow Wilson’s doctor and accompanied him to the Paris Peace Conference. Harrison died in 1958 at the age of seventy-one.

If a man will begin
⁷⁵³
with certainties, he shall end in doubts; but if he will be content to begin with doubts, he shall end in certainties.

—F
RANCIS
B
ACON

BREAKING WITH THE
dead hand of the gold standard
⁷⁵⁴
was the key to economic revival. Britain did so in 1931 and began its recovery that year. The United States followed in March 1933 and that proved to be the low point in its depression. France hung on to its link with gold for the longest. In 1935, Clément Moret was fired as governor of the Banque de France for resisting government measures to utilize its gold reserves to expand credit. Only in the following year did France finally abandon the gold standard. It was thus the last of the major economies to emerge from depression.

The exception to this pattern was Germany. After the summer 1931 crisis, it defaulted on reparations and introduced exchange controls. But it never officially left the gold standard. Still obsessed by an archaic fear of inflation, a carryover from 1923, and despite having no gold reserves, Germany decided to act as if it were still on gold, nailing itself to a sort of shadow standard and thereby forgoing the benefits of a cheap currency. When Britain devalued the pound in September, German foreign trade completely collapsed.

The continued economic slide in 1932 precipitated even more political turmoil. In May 1932, Brüning was turned out of office by a right-wing cabal. The following month, France and Britain, finally recognizing that it was impossible to squeeze any money out of Germany in the current environment, formally agreed to forgive all reparations. In the fourteen years since these had first been imposed, the Allies, who had once demanded $32 billion, and had settled on $12 billion, had succeeded in collecting a grand total of $4 billion from their old enemy.

Brüning was replaced by Franz von Papen, an ex-cavalry officer from an impoverished aristocratic family who had married into wealth and whose only talent was his horsemanship. In August, he called new elections, in which the Nazis won 230 seats, more than double their previous
representation, making them the largest party in the Reichstag. But President Von Hindenburg was not yet ready to invite the “Bohemian Corporal,” as he referred to Hitler, to become chancellor.

In 1931, Hjalmar Schacht had been interviewed by the American journalist Dorothy Thompson. “If Hitler comes to power
⁷⁵⁵
, the Nazis can’t run the country financially, economically. Who will run it?” she asked. “I will,” replied Schacht. “The Nazis cannot rule, but I can and will rule through them.” It had become clear to him even then that it was only a matter of time before Hitler would become chancellor.

Schacht would later claim that he never allowed himself to fall under Hitler’s spell and that because Hitler needed him, he was able to maintain a certain degree of independence. This is not apparent in a creepy letter he wrote to Hitler after the August elections, congratulating him on his victory and regretting that he was not already chancellor: “Your movement is carried internally
⁷⁵⁶
by so strong a truth and necessity that victory in one form or another cannot elude you for long. During the time of the rise of your movement you did not let yourself be led astray by false gods. . . . If you remain the man that you are the success cannot elude you for long.” But the main purpose of the letter was to urge Hitler to avoid becoming entangled in economic ideology—for Schacht realized that if he wanted to run Nazi economic policy, he would have to counteract some of the anticapitalist sloganeering of the party’s left. At this stage he believed that its virulently anti-Semitic ragings were restricted to a lunatic fringe. He ended by saluting Hitler “with a vigorous Heil.”