A History of Money and Banking in the United States: The Colonial Era to World War II (60 page)

84Moreau did resist Norman’s pressure to inflate the franc further, and he repeatedly urged Norman to meet Britain’s gold losses by tightening money and raising interest rates in England, thereby checking British purchase of francs and attracting capital at home. All this urging was to no avail, Norman being committed to a cheap-money policy. Rothbard,
America’s Great Depression
, p. 141.

The Gold-Exchange Standard in the Interwar Years
413

although he agreed to help England by buying gold from New York instead of London, (that is, drawing down dollar balances instead of sterling). Strong, in turn, agreed to supply France with gold at a subsidized rate: as cheap as the cost of buying it from England, despite the far higher transportation costs.85

Schacht was even more adamant, expressing his alarm at the extent to which bank credit expansion had already gone in England and the United States. The previous year, Schacht had acted on his concerns by reducing his sterling holdings to a minimum and increasing the holdings of gold in the Reichsbank. He told Strong and Norman: “Don’t give me a low

[interest] rate. Give me a true rate. Give me a true rate, and then I shall know how to keep my house in order.”86 Thereupon, Schacht and Rist sailed for home, leaving Strong and Norman to plan the next round of coordinated inflation themselves. In particular, Strong agreed to embark on a mighty inflationary push in the United States, lowering interest rates and expanding credit—an agreement which Rist, in his memoirs, maintains had already been privately concluded before the four-power conference began. Indeed, Strong gaily told Rist during their meeting that he was going to give “a little
coup de whiskey
to the stock market.”87 Strong also agreed to buy $60 million more of sterling from England to prop up the pound.

Pursuant to the agreement with Norman, the Federal Reserve promptly launched its greatest burst of inflation and cheap credit in the second half of 1927. This period saw the 85Ibid.

86Anderson,
Economics and Public Welfare,
p. 181. Schacht had stabilized the German mark in a new Rentenmark after the old mark had been destroyed by a horrendous runaway inflation by the end of 1923. The following year, he put the mark on the gold-exchange standard.

87Charles Rist, “Notice Biographique,”
Revue d’Economie Politique
(November–December, 1955): 1006ff.

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A History of Money and Banking in the United States:
The Colonial Era to World War II

largest rate of increase of bank reserves during the 1920s, mainly due to massive Fed purchases of U.S. government securities and of bankers’ acceptances, totaling $445 million in the latter half of 1927. Rediscount rates were also lowered, inducing an increase in bills discounted by the Fed. Benjamin Strong decided to sucker the suspicious regional Federal Reserve banks by using Kansas City Fed Governor W.J. Bailey as the stalking horse for the rate-cut policy. Instead of the New York Fed initiating the rediscount rate cut from 4 percent to 3.5 percent, Strong talked the trusting Bailey into taking the lead on July 29, with New York and the other regional Feds following a week or two later. Strong told Bailey that the purpose of the rate cuts was to help the farmers, a theme likely to appeal to Bailey’s agricultural region. He made sure
not
to tell Bailey that the major purpose was to help England pursue its inflationary gold-exchange policy.

The Chicago Fed, however, balked at lowering its rates, and Strong got the Federal Reserve Board in Washington to force it to do so in September. The isolationist
Chicago Tribune
angrily called for Strong’s resignation, charging correctly that discount rates were being lowered in the interests of Great Britain.88

After generating the burst of inflation in 1927, the New York Fed continued, over the next two years, to do its best: buying 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 into the U.S. The New York Fed also bought large amounts of sterling bills in 1927 and 1929. It frankly described its policy as follows: We sought to support exchange by our purchases and thereby not only prevent the withdrawal of further amounts 88Anderson,
Economics and Public Welfare
, pp. 182–83. See also Rothbard,
America’s Great Depression
, pp. 140–42; Beckhard, “Federal Reserve Policy,” pp. 67ff.; and Lawrence E. Clark,
Central Banking Under
the Federal Reserve System
(New York: Macmillan, 1935), p. 314.

The Gold-Exchange Standard in the Interwar Years
415

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.89

If Strong was the point man for the monetary inflation of the late 1920s, the Coolidge administration was not far behind.

Pittsburgh multimillionaire Andrew W. Mellon, secretary of the Treasury throughout the Republican era of the 1920s, was long closely allied with the Morgan interests. As early as March 1927, Mellon assured everyone that “an abundant supply of easy money” would continue to be available, and he and President Coolidge repeatedly acted as the “
capeadores
of Wall Street,” giving numerous newspaper interviews urging stock prices upward whenever prices seemed to flag. And in January 1928, the Treasury announced that it would refund a 4.5-percent Liberty Bond issue, falling due in September, in 3.5-percent notes. Within the administration, Mellon was consistently Strong’s staunchest supporter. The only sharp critic of Strong’s inflationism within the administration was Secretary of Commerce Herbert C. Hoover, only to be met by Mellon’s denouncing Hoover’s “alarmism” and interference.90

The motivation for Benjamin Strong’s expansionary policy of the late 1920s was neatly summed up in a letter by one of his top aides to one of Montagu Norman’s top henchmen, Sir Arthur Salter, then director of Economic and Financial Organization for the League of Nations. The aide noted that Strong, in the spring of 1928, “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 89Clark,
Central Banking Under the Federal Reserve
, p. 198.

90Unfortunately, Hoover shortsightedly attacked only credit expansion
in the stock market
rather than credit expansion per se. Rothbard,
America’s Great Depression
, pp. 142–43; Anderson,
Economics and Public
Welfare,
p. 182; Ralph W. Robey, “The
Capeadores
of Wall Street,”
Atlantic
Monthly
(September 1928); and Harold L. Reed,
Federal Reserve Policy,
1921–1930
(New York: McGraw-Hill, 1930), p. 32.

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A History of Money and Banking in the United States:
The Colonial Era to World War II

a sound financial and monetary basis.”91 Similarly, a prominent banker admitted to H. Parker Willis in the autumn of 1926 that bad consequences would follow America’s cheap-money policy, but that “that cannot be helped. It is the price we must pay for helping Europe.” Of course, the price paid by Strong and his allies was not so “onerous,” at least in the short run, when we note, as Dr. Clark pointed out, that the cheap credit aided especially those speculative, financial, and investment banking interests with whom Strong was allied—notably, of course, the Norman complex.92 The British, as early as mid-1926, knew enough to be appreciative. Thus, the influential London journal,
The Banker
, wrote of Strong that “no better friend of England” existed.
The Banker
praised the “energy and skillfulness that he has given to the service of England,” and exulted that

“his name should be associated with that of Mr. [Walter Hines]

Page as a friend of England in her greatest need.”93

On the other hand, Morgan partner Russell C. Leffingwell was not nearly as sanguine about the Strong-Norman policy of joint credit expansion. When, in the spring of 1929, Leffingwell heard reports that Monty was getting “panicky” about the speculative boom in Wall Street, he impatiently told fellow Morgan partner Thomas W. Lamont, “Monty and Ben sowed the wind.

I expect we shall all have to reap the whirlwind. . . . I think we are going to have a world credit crisis.”94

91O. Ernest Moore to Sir Arthur Salter, May 25, 1928. In Chandler,
Benjamin Strong
, pp. 280–81.

92Willis was a leading and highly perceptive critic of America’s inflationary policies in the interwar period. H. Parker Willis, “The Failure of the Federal Reserve,”
North American Review
(May 1929): 553. Clark’s study was written as a doctoral thesis under Willis. Clarke,
Central
Banking Under the Federal Reserve
, p. 344.

93Page was the Anglophile ambassador to Great Britain under Wilson and played a large role in getting the United States in the war. Clark,
Central Banking Under the Federal Reserve
, p. 315.

94Chernow,
House of Morgan
, p. 313.

The Gold-Exchange Standard in the Interwar Years
417

Unfortunately, Benjamin Strong was not destined personally to reap the whirlwind. A sickly man, Strong in effect was not running the Fed throughout 1928, finally dying on October 16

of that year. He was succeeded by his handpicked choice, George L. Harrison, also a Morgan man but lacking the personal and political clout of Benjamin Strong.

At first, as in 1924, Strong’s monetary inflation was temporarily successful in accomplishing Britain’s goals. Sterling was strengthened, and the American gold inflow from Britain was sharply reversed, gold flowing outward. Farm produce prices, which had risen from an index of 100 in 1924 to 110 the following year, and had then slumped back to 100 in 1926 and 99 in 1927, now jumped up to 106 the following year. Farm and food exports spurted upward, and foreign loans in the United States were stimulated to new heights, reaching a peak in mid-1928.

But, once again, the stimulus was only temporary. By the summer of 1928, the pound sterling was sagging again. American farm prices fell slightly in 1929, and agricultural exports fell in the same year. Foreign lending slumped badly, as both domestic and foreign funds poured into the booming American stock market.

The stock market had already been booming by the time of the fatal injection of credit expansion in the latter half of 1927.

The Standard and Poor’s industrial common stock index, which had been 44.4 at the beginning of the 1920s boom in June 1921, had more than doubled to 103.4 by June 1927. Standard and Poor’s rail stocks had risen from 156.0 in June 1921 to 316.2 in 1927, and public utilities from 66.6 to 135.1 in the same period.

Dow Jones industrials had doubled from 95.1 in November 1922 to 195.4 in November 1927. But now, the massive Fed credit expansion in late 1927 ignited the stock market fire. In particular, throughout the 1920s, the Fed deliberately and unwisely stimulated the stock market by keeping the “call rate,” that is, the interest rate on bank call loans to the stock market, artificially low. Before the establishment of the Federal Reserve System, the call rate frequently had risen far above 100 percent,
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A History of Money and Banking in the United States:
The Colonial Era to World War II

when a stock market boom became severe; yet in the historic and virtually runaway stock market boom of 1928–29, the call rate never went above 10 percent. The call rates were controlled at these low levels by the New York Fed, in close collaboration with, and at the advice of, the Money Committee of the New York Stock Exchange.95 The stock market, during 1928 and 1929, went into overdrive, virtually doubling these two years.

The Dow went up to 376.2 on August 29, 1929, and Standard and Poor’s industrials rose to 195.2, rails to 446.0, and public utilities to 375.1 in September. Credit expansion always concentrates its booms in titles to capital, in particular stocks and real estate, and in the late 1920s, bank credit propelled a massive real estate boom in New York City, in Florida, and throughout the country. These included excessive mortgage loans and construction from farms to Manhattan office buildings.96

The Federal Reserve authorities, now concerned about the stock market boom, tried feebly to tighten the money supply during 1928, but they failed badly. The Fed’s sales of government securities were offset by two factors: (a) the banks shifting their depositors from demand deposits to “time” deposits, which required a much lower rate of reserves, and which were really savings deposits redeemable de facto on demand, rather than genuine time loans, and (b) more important, the fruit of the disastrous Fed policy of virtually creating a market in bankers’

acceptances, a market which had existed in Europe but not in the United States. The Fed’s policy throughout the 1920s was to subsidize and in effect create an acceptance market by standing 95Rothbard,
America’s Great Depression
, p. 116; Clarke,
Central Banking
Under the Federal Reserve,
p. 382; Adolph C. Miller, “Responsibilities for Federal Reserve Policies, 1927–1929,”
American Economic Review
(September 1935).

96On the real estate boom of the 1920s, see Homer Hoyt, “The Effect of Cyclical Fluctuations upon Real Estate Finance,”
Journal of Finance
(April 1947): 57.

The Gold-Exchange Standard in the Interwar Years
419

ready to buy any and all acceptances sold by certain favored acceptance houses at an artificially cheap rate. Hence, when bank reserves tightened as the Fed sold securities in 1928, the banks simply shifted to the acceptance market, expanding their reserves by selling acceptances to the Fed. Thus, the Fed’s selling of $390 million of securities was partially offset, during latter 1928, by its purchase of nearly $330 million of acceptances.97

The Fed’s sticking to this inflationary policy in 1928 was now made easier by adopting the fallacious “qualitativist” view, held as we have seen also by Herbert Hoover, that the Fed could dampen down the boom by restricting loans to the stock market while merrily continuing to inflate in the acceptance market.