Modern Times: The World From the Twenties to the Nineties (46 page)

Great stock-exchange crises, with their spectacular reversals of fortune and human dramas, make the dry bones of economic history live. But they do not help to illuminate causes and consequences of events; quite the contrary. They enormously increase the mythology which is such a potent element in economic explanation. The nature of 1920s prosperity; the reason why it ended; the cause of the Great Crash and the Great Depression which followed; and, not least, the manner and means whereby the industrial societies emerged from it –
all these are still matters of intense argument. The conventional account is largely moralistic:
hubris
followed by
nemesis
, wicked greed by salutary retribution. It is easily adapted to Marxist determinism, which of course is a form of moral, not economic, analysis. It may make an edifying tale but it does not tell us what actually happened, let alone why. The interpretation provided by the followers of Keynes, which was the received opinion of the 1950s and 1960s, no longer carries conviction, for it appeared to be refuted by the catastrophic economic events of the 1970s and early 1980s, which placed the Great Depression in an entirely new perspective. Indeed, the two episodes can no longer be usefully studied separately and it is likely that future historians will analyse them in conjunction. But it is most improbable that an agreed explanation of either, or both, will ever be forthcoming. Economic history is too closely linked to current economic theory and practice to be a matter for easy consensus. What is offered here, then, is a possible account, which seeks to remove certain misconceptions.

The first fallacy to be dispelled is that America pursued an isolationist foreign policy in the 1920s. That is not true.
⁵
While America’s rulers would not formally underwrite the Versailles peace settlement, still less Keynes’s proposal for an American government-sponsored aid programme for European recovery, they privately and unostentatiously accepted a degree of responsibility for keeping the world economy on an even keel. They agreed to share with Britain the business of providing a global currency in which world trade could be conducted, a burden carried by the City of London virtually alone up to 1914. They also took it upon themselves to promote, by informal commercial and financial diplomacy, the expansion of world trade.
⁶
Unfortunately, the means employed were devious and ultimately dishonest. Except during the years 1857–61, America had always been a high-tariff nation: US tariffs, which had been imitated in continental Europe, were the chief refutation of its claim to conduct its affairs on true capitalist,
laissez-faire
principles. If Harding, Coolidge and Hoover had acted on the entrepreneurial principles they proudly proclaimed, they would have resumed Wilson’s abortive policy of 1913 of reducing US tariffs. In fact they did the opposite. The Fordney-MacCumber Tariff Act of 1922 and, still more, the Hawley-Smoot Act of 1930, which Hoover declined to veto, were devastating blows struck at world commerce, and so in the end at America’s own.
⁷
The fact is that America’s presidents, and her congressional leadership, lacked the political courage to stand up to the National Association of Manufacturers, the American Federation of Labour and local pressures, and so pursue internationalism in the most effective way open to them and the one which conformed most closely to the economic views they claimed to hold.

Instead, they sought to keep the world prosperous by deliberate inflation of the money supply. This was something made possible by the pre-war creation of the Federal Reserve Bank system, and which could be done secretly, without legislative enactment or control, and without the public knowing or caring. It did not involve printing money: the currency in circulation in the US was $3.68 billion at the beginning of the 1920s and $3.64 billion when the boom ended in 1929. But the expansion of total money supply, in money substitutes or credit, was enormous: from $45.3 billion on 30 June 1921 to over $73 billion in July 1929, an increase of 61.8 per cent in eight years.
⁸
The White House, the Treasury under Andrew Mellon, the Congress, the federal banks, and of course the private banks too, connived together to inflate credit. In its 1923,
Annual Report
, the Federal Reserve described the policy with frank crudity: ‘The Federal Reserve banks are … the source to which the member banks turn when the demands of the business community have outrun their own unaided resources. The Federal Reserve supplies the needed additions to credit in times of business expansion and takes up the slack in times of business recession.’
⁹
This policy of continuous credit-inflation, a form of vulgar Keynesianism before Keynes had even formulated its sophisticated version, might have been justified if interest rates had been allowed to find their own level: that is, if manufacturers and farmers who borrowed money had paid interest at the rate savers were actually prepared to lend it. But again, the White House, the Treasury, the Congress and the banks worked in consort to keep discount and interest rates artificially low. Indeed it was the stated policy of the Federal Reserve not only to ‘enlarge credit resources’ but to do so ‘at rates of interest low enough to stimulate, protect and prosper all kinds of legitimate business’.
¹⁰

This deliberate interference in the supply and cost of money was used in the 1920s not merely to promote its original aim, the expansion of US business, but to pursue a supposedly benevolent international policy. While the government demanded the repayment of its war-loans, it actively assisted foreign governments and businesses to raise money in New York both by its own cheap money policy and by constant, active interference in the foreign bond marker. The government made it quite clear that it favoured certain loans and not others. So the foreign loan policy was an adumbration, at the level of private enterprise, of the post-1947 foreign aid programme. The aims were the same: to keep the international economy afloat, to support certain favoured regimes and, not least, to promote America’s export industries. It was made, in effect, a condition of cabinet boosting of specific loans that part of them were spent in the USA. The foreign lending boom began in 1921,
following a cabinet decision on 20 May 1921 and a meeting between Harding, Hoover and US investment bankers five days later, and it ended in late 1928, thus coinciding precisely with the expansion of the money supply which underlay the boom. America’s rulers, in effect, rejected the rational
laissez-faire
choice of free trade and hard money and took the soft political option of protective tariffs and inflation. The domestic industries protected by the tariff, the export industries subsidized by the uneconomic loans and of course the investment bankers who floated the bonds all benefited. The losers were the population as a whole, who were denied the competitive prices produced by cheap imports, suffered from the resulting inflation, and were the universal victims of the ultimate
dégringolade.
¹¹

Moreover, by getting mixed up in the foreign loan business, the government forfeited much of its moral right to condemn stock-exchange speculation. Hoover, who was Commerce Secretary throughout the 1920s until he became President, regarded Wall Street as a deplorable casino – but he was the most assiduous promoter of the foreign bond market. Even bad loans, he argued, helped American exports and so provided employment.
¹²
Some of the foreign bond issues, however, were at least as scandalous as the worst stock-exchange transactions. Thus, in 1927, Victor Schoepperle, Vice-President for Latin-American loans at National City Company (affiliated to National City Bank), reported on Peru: ‘Bad debt record; adverse moral and political risk; bad internal debt situation; trade situation about as satisfactory as that of Chile in the past three years. National resources more varied. On economic showing Peru should go ahead rapidly in the next ten years.’ Nevertheless National City floated a $15 million loan for Peru, followed shortly afterwards by a $50 million loan and a $25 million issue. Congressional investigation, in 1933–4, established that Juan Leguia, son of the president of Peru, had been paid $450,000 by National and its associates in connection with the loan. When his father was overthrown Peru defaulted.
¹³
This was one example among many. The basic unsoundness of much of the foreign loan market was one of the principal elements in the collapse of confidence and the spread of the recession to Europe. And the unsoundness was the consequence not, indeed, of government
laissez-faire
but of the opposite: persistent government meddling.

Interventionism by creating artificial, cheap credit was not an American invention. It was British. The British called it ‘stabilization’. Although Britain was nominally a
laissez-faire
country up to 1914, more so than America in some respects since it practised free trade, British economic philosophers were not happy with the
business cycle, which they believed could be smoothed out by deliberate and combined efforts to achieve price stabilization. It must not be thought that Keynes came out of a clear non-interventionist sky: he was only a marginal ‘advance’ on the orthodox British seers. Since before the war Sir Ralph Hawtrey, in charge of financial studies at the Treasury, had argued that the central banks, by creating international credit (that is, inflation), could achieve a stable price level and so enormously improve on the nineteenth century’s passive acceptance of the cycle, which he regarded as immoral. After 1918, Hawtrey’s views became the conventional wisdom in Britain and spread to America via Versailles. In the 1920 recession the Stable Money League (later the National Monetary Association) was founded, attracting the American financial establishment and, abroad, men like Emile Moreau, Governor of the Bank of France, Edouard Benes, Lord Melchett, creator of
ICI
, Louis Rothschild, head of the Austrian branch, A.J.Balfour and such British economists as A.C.Pigou, Otto Kahn, Sir Arthur Salter and Keynes himself.
¹⁴

Keynes put the case for a ‘managed currency’ and a stabilized price-level in his
Tract on Monetary Reform
(1923). By then, stabilization was not merely accepted but practised. Hawtrey had inspired the stabilization resolutions of the Genoa Conference in 1922; the Financial Committee of the League of Nations was stabilizationist; most of all, the Bank of England was stabilizationist. Montagu Norman, its governor, and his chief international adviser Sir Charles Addis, were both ardent apostles of the creed. Their principal disciple was Benjamin Strong, governor of the New York Federal Reserve Bank, who until his death in 1928 was all-powerful in the formation of American financial policy. Hoover called Strong, justly, ‘a mental annex to Europe’, and he was the effective agent in America’s covert foreign policy of economic management. Indeed it is not too much to say that, for most of the 1920s, the international economic system was jointly supervised by Norman and Strong.
¹⁵
It was Strong who made it possible for Britain to return to the gold standard in 1925, by extending lines of credit from the New York Federal Reserve Bank and getting J.P.Morgan to do likewise: the London
Banker
wrote: ‘no better friend of England exists’. Similar lines of credit were opened later to Belgium, Poland, Italy and other countries which met the Strong-Norman standards of financial rectitude.
¹⁶

Of course the ‘gold standard’ was not a true one. That had gone for good in 1914. A customer could not go into the Bank of England and demand a gold sovereign in return for his pound note. It was the same in other European gold-standard countries. The correct term
was ‘gold bullion standard’: the central banks held gold in large bars but ordinary people were not considered sufficiently responsible to handle gold themselves (although in theory Americans could demand gold dollars until 1933). Indeed, when a plan was produced in 1926 to give India a real gold standard, Strong and Norman united to kill it, on the grounds that there would then be a disastrous world-wide gold-drain into Indian mattresses. In short, the 1920s gold-standard movement was not genuine
laissez-faire
at all but a ‘not in-front-of-the-servants’
laissez-faire.
¹⁷
It was a benevolent despotism run by a tiny élite of the Great and the Good, in secret. Strong regarded his credit-expansion and cheap money policy as an alternative to America backing the League, and he was pretty sure US public opinion would repudiate it if the facts were made public: that was why he insisted the periodic meetings of bankers should be strictly private. A financial policy which will not stand the scrutiny of the public is suspect in itself. It is doubly suspect if, while making gold the measure of value, it does not trust ordinary people – the ultimate judges of value – to apply that measurement themselves. Why did the bankers fear that ordinary men and women, if given the chance, would rush into gold – which brought no return at all – when they could invest in a healthy economy at a profit? There was something wrong here. The German banker Hjalmar Schacht repeatedly called for a true gold standard, as the only means to ensure that expansion was financed by genuine voluntary savings, instead of by bank credit determined by a tiny oligarchy of financial Jupiters.
¹⁸

But the stabilizers carried all before them. Domestically and internationally they constantly pumped more credit into the system, and whenever the economy showed signs of flagging they increased the dose. The most notorious occasion was in July 1927, when Strong and Norman held a secret meeting of bankers at the Long Island estates of Ogden Mills, the US Treasury Under-Secretary, and Mrs Ruth Pratt, the Standard Oil heiress. Strong kept Washington in the dark and refused to let even his most senior colleagues attend. He and Norman decided on another burst of inflation and the protests of Schacht and of Charles Rist, Deputy-Governor of the Bank of France, were brushed aside. The New York Fed reduced its rate by a further half per cent to 3
; as Strong put it to Rist, ‘I will give a little
coup de whiskey
to the stock-market’ – and as a result set in motion the last culminating wave of speculation. Adolph Miller, a member of the Federal Reserve Board, subsequently described this decision in Senate testimony as ‘the greatest and boldest operation ever undertaken by the Federal Reserve System [which] resulted in one of the most costly errors committed by it or any other banking system in the last seventy-five years.’
¹⁹