America's Great Depression (27 page)

In short, the Cabinet wished that banks floating foreign loans provide that part of the proceeds be spent in the United States. And Herbert Hoover was so enthusiastic about subsidizing foreign loans that he commented that even
bad
loans helped American exports and thus provided a cheap form of relief and employment—a “cheap” form that later brought expensive defaults and financial distress.8

In January, 1922, Secretary of Commerce Hoover prevailed on American investment bankers to agree that agents of the Department of Commerce would first investigate conditions in countries requesting foreign loans, whether the would-be borrowers were private or public. The applicant would also have to promise to purchase materials in the United States, and the fulfillment of this agreement would be inspected by an American commercial attachè in the borrowing country. Happily, little came of this agreement.

In the meanwhile, the Harding request was repeatedly ignored, and consequently the State Department sent a circular letter to the investment bankers in March, 1922, repeating the Presidential 6Jacob Viner, “Political Aspects of International Finance,”
Journal of Business
(April, 1928): 170. Also see Herbert Hoover,
The Memoirs of Herbert Hoover
(New York: Macmillan, 1952), vol. 2, pp. 80–86.

7Jacob Viner, “Political Aspects of International Finance, Part II,”
Journal of
Business
(July, 1928): 359.

8Harris Gaylord Warren,
Herbert Hoover and the Great Depression
(New York: Oxford University Press, 1959), p. 27.

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request, admitting that it was legally unenforceable, but declaim-ing that “national interests” required that the State Department offer its objections to any bond issue. During April and May, Secretary Hoover protested the bankers’ reluctance, and urged that banks be ordered to establish his desired rules for foreign loans, else Congress would assume control. Harding and Coolidge, however, contented themselves with a far milder form of informal intimidation.

Often the government, when challenged, denied any attempt at dictation over foreign loans. But the State Department admitted several times that it was exercising beneficial control, and admitted it had objected to a number of loans. The most noteworthy ban was on all loans to France, a punishment levied because France was still in debt to the American government. It was a ban which the bankers were often able to evade. Secretary of State Kellogg favored, but could not obtain, outright legal regulation of foreign lending.

Knowing that the State Department was intervening in foreign lending, the American public erroneously began to believe that every foreign loan had the Federal government’s seal of approval and was therefore a good buy. This, of course, stimulated reckless foreign lending all the more.

The foreign lending of the 1920s was almost all private. In 1922, however, in a harbinger of much later developments, Secretary of State Hughes urged Congress to approve a direct
governmental
loan of five million dollars to Liberia, but the Senate failed to ratify it.

HELPING BRITAIN

The great expansion of 1924 was designed not only to stimulate loans to foreign countries but also to check their drains of gold to the United States.9 The drains arose, primarily, from the inflationary policies of the foreign countries. Great Britain, in particular, faced a grave economic problem. It was preparing to return to the 9As we have indicated above, a third motive for the 1924 credit expansion was to promote recovery in agriculture and business from the mild 1923 recession.

The Development of the Inflation

143

gold standard at the pre-war par (the pound sterling equaling approximately $4.87), but this meant going back to gold at an exchange rate higher than the current free-market rate. In short, Britain insisted on returning to gold at a valuation that was 10–20

percent higher than the going exchange rate, which reflected the results of war and postwar inflation. This meant that British prices would have had to decline by about 10 to 20 percent in order to remain competitive with foreign countries, and to maintain her all-important export business. But no such decline occurred, primarily because unions did not permit wage rates to be lowered. Real-wage rates rose, and chronic large-scale unemployment struck Great Britain. Credit was not allowed to contract, as was needed to bring about deflation, as unemployment would have grown even more menacing—an unemployment caused partly by the postwar establishment of government unemployment insurance (which permitted trade unions to hold out against any wage cuts). As a result, Great Britain tended to lose gold. Instead of repealing unemployment insurance, contracting credit, and/or going back to gold at a more realistic parity, Great Britain inflated her money supply to offset the loss of gold and turned to the United States for help. For if the United States government were to inflate
American
money, Great Britain would no longer lose gold to the United States. In short, the American public was nominated to suffer the burdens of inflation and subsequent collapse in order to maintain the British government and the British trade union movement in the style to which they insisted on becoming accustomed.10

The American government lost no time in rushing to the aid of Britain. The “isolationism” of U.S. foreign policy in the 1920s is almost wholly a myth, and nowhere is this more true than in economic and financial matters. The 1927 conference between the leading central bankers that led to the inflation of that year has become famous; less well known is the fact that close collaboration between Benjamin Strong, Governor of the Federal Reserve Bank 10See Lionel Robbins,
The Great Depression
(New York: Macmillan, 1934), pp. 77–87; Sir William Beveridge,
Unemployment
,
A Problem of Industry
(London: Macmillan, 1930), chap. 16; and Frederic Benham,
British Monetary Policy
(London: P.S. King and Son, 1932).

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of New York, and Montagu Norman, head of the Bank of England, began much earlier. On Norman’s appointment as Governor during the War, Strong hastened to promise him his services. In 1920, Norman began taking annual trips to America to visit Strong, and Strong took periodic trips to visit Europe. All of these consultations were kept highly secret and were always camouflaged as “visiting with friends,” “taking a vacation,” and “courtesy visits.” The Bank of England gave Strong a desk and a private secretary for these occasions, as did the Bank of France and the German Reichsbank. These consultations
were not
reported to the Federal Reserve Board in Washington.11 Furthermore, the New York Bank and the Bank of England kept in close touch via weekly exchange of private cables.

As the eminent French economist Charles Rist, who represented the Bank of France at some of the important inter-Central Bank conferences, has declared:

The idea of cooperation among the central banks of dif -

ferent countries, to arrive at a common monetary policy, was born rather soon after the war. Before then, this cooperation had only been exceptional and sporadic.12

As early as 1916, Strong began private correspondent relations with the Bank of England, as well as with other European Central Banks. In the summer of 1919, Strong was already contemplating a secret conference of central bankers, and, moreover, was already worried about American interest rates being higher than the British, and thinking of arrangements with the Bank of England to remedy this condition, thus foreshadowing the later agreements to inflate in America in order to aid Britain.13 In November, 1921

Strong offered Norman a dollar-stabilization scheme, in the course of which the Federal Reserve would lend dollars to Britain, Holland, 11Lawrence E. Clark,
Central Banking Under the Federal Reserve System
(New York: Macmillan, 1935), pp. 310ff.

12Charles Rist, “Notice Biographique,”
Revue d’Économie Politique
(November–

December, 1955): 1005. (Translation mine.)

13Lester V. Chandler,
Benjamin Strong, Central Banker
(Washington, D.C.: Brookings Institution, 1958), pp. 147–49.

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145

Scandinavia, Japan, and Switzerland; but Norman turned the proposal down.14

In 1925, the year Britain returned to the gold standard, the United States helped greatly. As a direct measure, the New York Bank extended Britain a line of credit for gold of up to $200 million.15 At the same time, J.P. Morgan and Company authorized a similar credit of $100 million to the British government, a loan that would have been subsidized (if it had ever been used) by the Federal Reserve. Both loans were arranged by Strong and Norman in early January, 1925, and were warmly approved by Secretary of Treasury Mellon, Governor Crissinaer, and unanimously by the Federal Reserve Board.16 Similar lines of credit were extended to bolster the Central Banks of Belgium ($10 million in 1926), Poland ($5 million in 1927), and Italy ($15 million in 1927).

More insidious and damaging was aiding Britain by inflating in the U.S. The 1924 expansion in America was much more than coincidence with preparation for Britain’s return to gold. For the pound sterling had fallen to $4.44 in mid-1922, and by mid-1924

was in even worse shape at $4.34. At that point, matters took a decisive turn. American prices began to rise [due to the American inflation]. . . . In the foreign 14Sir Henry Clay,
Lord Norman
(London: Macmillan, 1957), pp. 140–41.

15Former Assistant Secretary of the Treasury Oscar T. Crosby perceptively attacked this credit at the time as setting a dangerous precedent for inter-governmental lending.
Commercial and Financial Chronicle
(May 9, 1925): 2357ff.

16The Morgan credit was apparently instigated by Strong. See Chandler,
Benjamin Strong, Central Banker,
pp. 284ff, 308ff, 312ff. Relations between the New York Fed and the House of Morgan were very close throughout this period.

Strong had worked closely with the Morgan interests before assuming his post at the Federal Reserve. It is therefore significant that “J.P. Morgan and Company have been the fiscal agents in this country of foreign governments and have had

‘close working agreements’ with the Federal Reserve Bank of New York.” Clark,
Central Banking Under the Federal Reserve System,
p. 329. In particular, the Morgans were agents of the Bank of England. Also see Rist, “Notice Biographique.” To their credit, however, Morgans refused to go along with a Strong–Norman scheme to lend money to the Belgian government in order to prop up the Belgian exchange rate at an overvalued level, and thus subsidize inflationary Belgian policies.

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exchange markets a return to gold at the old parity was anticipated. The sterling-dollar exchange appreciated from $4.34 to $4.78. In the spring of 1925, therefore, it was thought that the adjustment between sterling and gold prices was sufficiently close to warrant a resumption of gold payments at the old parity.17

That this result was brought about deliberately through credit expansion in America, is clear from a letter from Strong to Mellon in the spring of 1924, outlining the necessity of raising American price levels relative to Great Britain’s and of lowering American interest rates, to enable Britain to return to gold. For higher American price levels would divert foreign trade balances from the United States to England, while lower interest rates would similarly divert capital balances. Lower interest rates, being a more immediate outcome of credit expansion, received more attention.

Strong concluded this letter as follows:

the burden of this readjustment must fall more largely upon us than upon them [Great Britain]. It will be difficult politically and socially for the British Government and the Bank of England to face a price liquidation in England . . . in face of the fact that their trade is poor and they have over a million unemployed people receiv -

ing government aid.18

It is clear that by late 1924, the foreign exchange market saw that the United States was inflating in order to help Britain, and, anticipating success, raised the pound nearly up to its prewar par—an appreciation caused by governmental action rather than by the fundamental economic realities. The Federal Reserve certainly kept its part of the rather one-sided bargain. Whereas throughout 1922 and 1923 the interest rate on bills in New York had been above the rate in London, the Federal Reserve managed to push these rates below those of London by mid-1924. As a result, the gold inflow into the United States, of which about 40 percent had 17Robbins,
The Great Depression,
p. 80.

18Strong to Mellon, May 27, 1924. Quoted in Chandler,
Benjamin Strong,
Central Banker,
pp. 283–84, 293ff.

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147

been coming from Great Britain, was checked for a time.19 As we have seen, U.S. lending abroad was also greatly stimulated, thus providing Europe with longer-term funds.

Inflationary measures to aid foreign governments also spurred farm exports, since foreign countries could now expand their purchases of American farm products. Farm prices rose in the latter half of 1924, and the value of farm exports increased by over 20

percent from 1923–1924 to 1924–1925. Yet, despite all the aid, we cannot say that the farmers particularly benefited from the foreign economic policies of the 1920s as a whole, since the protective tariff injured foreign demand for American products.

Instead of being grateful to the United States for its monetary policy, Europe carped continually during the 1920s because America wasn’t inflating enough. Even in the intimate Norman–Strong partnership, it is clear that, in the early years especially, Norman was continually trying to prod Strong into a more inflationary stance. In the 1919–1920 era, before the joint inflationary policy had begun, Norman’s Treasury colleague Basil Blackett urged Strong to let American prices “rise a little more”—and this in the middle of a postwar boom in America. Later, the British urged looser credit conditions in the U.S., but Strong was rather reluctant during this early period.