A History of Money and Banking in the United States: The Colonial Era to World War II (61 page)

In addition to pouring in funds through acceptances, the Fed did nothing to tighten its rediscount market. The Fed discounted $450 million of bank bills during the first half of 1928; it finally tightened a bit by raising its rediscount rates from 3.5

percent at the beginning of the year to 5 percent in July. After that, it stubbornly refused to raise the rediscount rate any further, keeping it there until the end of the boom. As a result, Fed discounts to banks rose slightly until the end of the boom instead of declining. Furthermore, the Fed failed to sell any more of its hoard of $200 million of government securities after July 1928; instead, it bought some securities on balance during the rest of the year.

Why was Fed policy so supine in late 1928 and in 1929? A crucial reason was that Europe, and particularly England, having lost the benefit of the inflationary impetus by mid-1928, was clamoring against any tighter money in the U.S. The easing in late 1928 prevented gold inflows from the U.S. from getting very large. Britain was again losing gold; sterling was again weak; and the United States once again bowed to its wish to see Europe avoid the consequences of its own inflationary policies.

97On the unfortunate Fed acceptance policy of the 1920s, see Rothbard,
America’s Great Depression
, pp. 117–23.

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

Leading the inflationary drive within the administration were President Coolidge and Treasury Secretary Mellon, eagerly playing their roles as the
capeadores
of the bull market on Wall Street. Thus, when the stock market boom began to flag, as early as January 1927, Mellon urged it onward. Another relaxing of stock prices in March spurred Mellon to call for and predict lower interest rates; again, a weakening of stock prices in late March induced Mellon to make his statement assuring

“an abundant supply of easy money which should take care of any contingencies that might arise.” Later in the year, President Coolidge made optimistic statements every time the rising stock market fell slightly. Repeatedly, both Coolidge and Mellon announced that the country was in a “new era” of permanent prosperity and permanently rising stock prices. On November 16, the
New York Times
declared that the administration in Washington was the source of most of the bullish news and noted the growing “impression that Washington may be depended upon to furnish a fresh impetus for the stock market.” The administration continued these bullish statements for the next two years. A few days before leaving office in March 1929, Coolidge called American prosperity “absolutely sound” and assured everyone that stocks were “cheap at current prices.”98, 99

98Rothbard,
America’s Great Depression
, p. 148. See also ibid., pp. 116–17; and Robey, “
Capeadores
.” The leading “bull” speculator of the era, former General Motors magnate William Crapo Durant, who was to get wiped out in the crash, hailed Coolidge and Mellon as the leaders of the boom.
Commercial and Financial Chronicle
(April 20, 1929): 2557ff.

99Some of Strong’s apologists claim that, if Strong had been at the helm, he would have imposed tight money in 1928. For an example, see Carl Snyder,
Capitalism, the Creator: The Economic Foundations of
Modern Industrial Society
(New York: Macmillan, 1940), pp. 227–28.

Snyder worked under Strong as head of the statistical department of the New York Fed. But we now know the contrary: that Strong protested against even the feeble restrictive measures during 1928 as being too severe, in a letter from Strong to Walter W. Stewart, August 3, 1928.

Stewart, formerly head of the Fed’s research division, had a few years
The Gold-Exchange Standard in the Interwar Years
421

The clamor from England against any tighter money in the U.S. was driven by England’s loss of gold and the pressure on sterling. France, having unwillingly piled up $450 million in sterling by the end of June 1928, was anxious to redeem sterling for gold, and indeed sold $150 million of sterling by mid-1929. In deference to Norman’s threats and pleas, however, the Bank of France sold that sterling for dollars rather than for gold in London. Indeed, so cowed were the French that (a) French sales of sterling in 1929–31 were offset by sterling purchases by a number of minor countries, and (b) Norman managed to persuade the Bank of France to sell no more sterling until after the disastrous day in September 1931 when Britain abandoned its own gold-exchange standard and went on to a fiat pound standard.100

Meanwhile, despite the great inflation of money and credit in the U.S., the massive increase in the supply of goods in the U.S.

continued to lower prices gradually, wholesale prices falling from 104.5 (1926=100) in November 1925 to 100 in 1926, and then to 95.2 in June 1929. Consumer price indices in the U.S.

also fell gradually in the late 1920s. Thus, despite Strong’s loose money policies, Norman could not count on price inflation in the U.S. to bail out his gold-exchange system. Montagu Norman, in addition to pleading with the U.S. to keep inflating, resorted to dubious short-run devices to try to keep gold from flowing out to the U.S. Thus, in 1928 and 1929, he would sell gold for sterling to raise the sterling rate a bit, in sales timed to coincide with the departure of fast boats from London to New York, thus inducing gold holders to keep the precious metal in London. Such short-run tricks were hardly adequate substitutes for tight money or for raising bank rate in England, and weakened long-run confidence in the pound sterling.101

earlier shifted to become economic adviser of the Bank of England, and had written to Strong warning of unduly tight restriction on American bank credit. Chandler,
Benjamin Strong
, pp. 459–65.

100Palyi,
Twilight of Gold
, pp. 187, 194.

101Anderson,
Economic and Public Welfare,
p. 201.

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

In March 1929, Herbert Clark Hoover, who had been a powerful secretary of commerce during the Republican administrations of the 1920s, became president of the United States. While not as intimately connected as Calvin Coolidge, Hoover long had been close to the Morgan interests. Mellon continued as secretary of the Treasury, with the post of secretary of state going to the longtime top Wall Street lawyer in the Morgan ambit, Henry L. Stimson, disciple and partner of J.P. Morgan’s personal attorney, Elihu Root.102 Perhaps most important, Hoover’s closest, but unofficial adviser, whom he regularly consulted three times a week, was Morgan partner Dwight Morrow.103

Hoover’s method of dealing with the inflationary boom was to try not to tighten the money supply, but to keep bank loans out of the stock market by a jawbone method then called

“moral suasion.” This too was the preferred policy of the new governor of the Federal Reserve Board in Washington, Roy A.

Young. The fallacy was to try to restrict credit to the stock market while keeping it abundant to “legitimate” commerce and 102Undersecretary of the Treasury Ogden Mills, Jr., who was to replace Mellon in 1931 and who was close to Hoover, was a New York corporate lawyer from a family long associated with the Morgan interests.

Hoover’s secretary of the Navy was Charles F. Adams, from a Boston Brahmin family long associated with the Morgans, and whose daughter married J.P. Morgan, Jr.

103Burch,
Elites in American History
, p. 280. For the important but private influence on President Hoover by Morgan partner Thomas W.

Lamont, including Lamont’s inducing Hoover to conceal his influence by faking entries in a diary that Hoover left to historians, see Ferguson,

“From Normalcy to New Deal,” p. 79.

The Morgans, in the 1928 Republican presidential race, were torn three ways: between inducing, unsuccessfully, President Coolidge to run for a third term; Vice President Charles G. Dawes, who had been a Morgan railroad lawyer and who dropped out of the 1928 race; and Herbert Hoover.

On Hoover’s worries before the nomination about the position of the Morgans, and on Lamont’s assurances to him, see the illuminating letter from Thomas W. Lamont to Dwight Morrow, December 16, 1927, in Ferguson, “From Normalcy to New Deal,” p. 77.

The Gold-Exchange Standard in the Interwar Years
423

industry. Using methods of intimidation of business honed when he was secretary of commerce, Hoover attempted to restrain stock loans by New York banks, tried to induce the president of the New York Stock Exchange to curb speculation, and warned leading editors and publishers about the dangers of high stock prices. None of these superficial methods could be effective.

Professor Beckhart added another reason for the adoption of the ineffective policy of moral suasion: that the administration had been persuaded to try this tack by the old manipulator, Montagu Norman. Finally, by June 1929, the moral suasion was at last abandoned, but discount rates were still not raised, so that the stock market boom continued to rage, even as the economy in general was quietly but inexorably turning downward. Secretary Mellon once again trumpeted our “unbroken and unbreakable prosperity.” In August, the Federal Reserve Board finally agreed to raise the rediscount rate to 6 percent, but any tightening effect was more than offset by the Fed’s simultaneously lowering its acceptance rate, thereby once again giving an inflationary fillip to the acceptance market.

One reason for this resumption of acceptance inflation, after it had been previously reversed in March, was, yet again,

“another visit of Governor Norman.”104 Thus, once more, the cloven hoof of Montagu Norman was able to give its final impetus to the boom of the 1920s. Great Britain was also entering upon a depression, and yet its inflationary policies resulted in a serious outflow of gold in June and July. Norman was able to get a line of credit of $250 million from a New York banking consortium, but the outflow continued through September, much of it to the United States. Continuing to help England, the New York Fed bought heavily in sterling bills from August through October. The new subsidization of the acceptance market, mostly foreign acceptances, permitted further aid to Britain through the purchase of sterling bills.

104Beckhart, “Federal Reserve Policy,” pp. 142ff. See also ibid., p. 127.

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

A perceptive epitaph on the qualitative-credit politics of 1928–29 was pronounced by A. Wilfred May: Once the credit system had become infected with cheap money, it was impossible to cut down particular outlets of this credit without cutting down all credit, because it is impossible to keep different kinds of money separated in water-tight compartments. It was impossible to make money scarce for stock-market purposes, while simultaneously keeping it cheap for commercial use. . . . When Reserve credit was created, there was no possible way that its employment could be directed into specific uses, once it had flowed through the commercial banks into the general credit stream.105

DEPRESSION AND THE END OF THE

GOLD-STERLING-EXCHANGE STANDARD: 1929–1931

The depression, or what nowadays would be called the “recession,” that struck the world economy in 1929 could have been met in the same way the U.S., Britain, and other countries had faced the previous severe contraction of 1920–21, and the way in which all countries met recessions under the classical gold standard. In short: they could have recognized the folly of the preceding inflationary boom and accepted the recession mechanism needed to return to an efficient free-market economy. In other words, they could have accepted the liquidation of unsound investments and the liquidation of egregiously unsound banks, and have accepted the contractionary deflation of money, credit, and prices. If they had done so, they would, as 105A. Wilfred May, “Inflation in Securities,” in
The Economics of
Inflation,
H. Parker Willis and John M. Chapman, eds. (New York: Columbia University Press, 1935), pp. 292–93; Charles O. Hardy,
Credit
Policies of the Federal Reserve System
(Washington, D.C.: Brookings Institution, 1932), pp. 124–77; Oskar Morgenstern, “Developments in the Federal Reserve System,”
Harvard Business Review
(October 1930): 2–3; and Rothbard,
America’s Great Depression
, pp. 151–52.

The Gold-Exchange Standard in the Interwar Years
425

in the previous cases, have encountered a recession-adjustment period that would have been sharp, severe, but mercifully short.

Recessions unhampered by government almost invariably work themselves into recovery within a year or 18 months.

But the United States, Britain, and the rest of the world had been permanently seduced by the siren song of cheap money. If inflationary bank credit expansion had gotten the world into this mess, then more, more of the same would be the only way out. Pursuit of this inflationist, “proto-Keynesian” folly, along with other massive government interventions to prevent price deflation, managed to convert what would have been a short, sharp recession into a chronic, permanent, stagnation with an unprecedented high unemployment that only ended with World War II.

Great Britain tried to inflate its way out of the recession, as did the United States, despite the monetarist myth that the Federal Reserve deliberately contracted the money supply from 1929 to 1933. The Fed inflated partly to help Britain and partly for its own sake. During the week of the great stock market crash—the final week of October 1929—the Federal Reserve, specifically George Harrison, doubled its holding of government securities, and discounted $200 million for member banks.

During that one week, the Fed added $300 million to bank reserves, the expansion being generated to prevent stock market liquidation and to permit the New York City banks to take over brokers’ loans being liquidated by nonbank lenders. Over the objections of Roy Young of the Federal Reserve Board, Harrison told the New York Stock Exchange that “I am ready to provide all the reserve funds that may be needed.”106 By December, Secretary Mellon issued one of his traditionally optimistic pronouncements that there was “plenty of credit available,” and President Hoover, addressing a business conference on December 5, hailed the nation’s good fortune in possessing 106Chernow,
House of Morgan
, p. 319.