America's Great Depression (28 page)

In February, 1922, Norman hailed the easy credit in America during the previous few months, and urged a further inflationary fall in interest rates to match the burgeoning credit expansion in Britain. At that time, Strong refused to inflate further, and Norman continued to pepper Strong during 1922 and 1923 with expressions of his displeasure at the American failure to expand credit. But in 1924, helped by the siren song of Britain’s return to the “gold standard” and by a mild recession at home, Strong capit-ulated, so much so that by October Norman was jauntily telling Strong, “You must continue with easy money and foreign loans and we must hold on tight until we know . . . what the policy of this 19See Benjamin H. Beckhart, “Federal Reserve Policy and the Money Market, 1923–1931,” in
The New York Money Market,
vol. 4, p. 45.

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country is to be.”20 And yet, Norman was not fully satisfied with his American servitor. Privately, he joined the general European opinion in criticizing the United States for violating the alleged

“rules of the gold standard game,” by not inflating in multiple proportion to the gold flowing into its coffers.21

This standard argument, however, completely misconceives the role and function of the gold standard and governmental responsibility under it. The gold standard is not some sort of “game,” to be played among several countries according to some mythical

“rules.” Gold is simply the monetary medium, and the duty of government is to leave the people free to do with the gold as they see fit. It is therefore its corollary duty not to inflate the money supply beyond the gold stock or to stimulate and encourage such inflation. If the money supply is already inflated, it is at least its responsibility not to inflate
further
. Whether money should be deflated back to the gold level is a more difficult question which we need not discuss here. If gold flows into a country, the government should welcome the opportunity to raise the gold deposit ratio, and thereby reduce the counterfeit proportion in the nation’s supply of money. Countries “lose gold” (since the drain is voluntary it cannot be a true “loss”) as a consequence of inflationary policies by their governments. These policies induce heavy domestic spending abroad (necessarily with gold) and discourage the nation’s export trade. If European countries disliked losing gold to the United States, their governments should have contracted and not inflated their money supply. Certainly it is absurd, though convenient, to pin the blame for the consequences of a government’s unsound policies upon the relatively sounder policies of
another
government.

The nobility of the American aim to help Europe return to the gold standard becomes even more questionable when we realize that Europe never
did
return to a full gold standard. Instead, it adopted a “gold bullion” standard, which prohibited gold coinage, 20Norman to Strong, October 16, 1924. Cited in Chandler,
Benjamin Strong,
Central Banker,
p. 302.

21Norman to Hjalmar Schacht, December 28, 1926. Cited in Clay,
Lord
Norman,
p. 224.

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149

thus restricting gold convertibility to heavy bars suitable only for large international transactions. Often it chose a “gold exchange” standard, under which a nation keeps its reserves not in gold but in a “hard” currency like dollars. It then redeems its units only in the other country’s harder currency. Clearly, this system permits an international “pyramiding” of inflation on the world’s given stock of gold. In both the gold bullion and the gold exchange standards, the currency is virtually fiat, since the people are
de facto
prohibited from using gold as their medium of exchange. The use of the term

“gold standard” by foreign governments in the 1920s, then, was more of a deception than anything else. It was an attempt to draw to the government the prestige of being on the gold standard, while actually failing to abide by the limitations and requirements of that standard. Great Britain, in the late 1920s, was on a gold bullion standard, and most other “gold standard countries” were on the gold exchange standard, keeping their titles to gold in London or New York. The British position, in turn, depended on American resources and lines of credit, since only America was on a true gold standard.

Thus, the close international Central Bank collaboration of the 1920s created a false era of seemingly sound prosperity, masking a dangerous worldwide inflation. As Dr. Palyi has declared, “The gold standard of the New Era was managed enough to permit the artificial lengthening and bolstering of the boom, but it was also automatic enough to make inevitable the eventual failure.”22 The prewar standard, Palyi points out, had been autonomous; the new gold standard was based on the political cooperation of central banks, which “impatiently fostered a volume of credit flow without regard to its economic results.” And Dr. Hardy justly concluded, “International cooperation to support the gold standard . . . is the maintenance of a cheap money policy without suffering the loss of gold.”23

22Melchior Palyi, “The Meaning of the Gold Standard,”
Journal of Business
(July, 1941): 300–01. Also see Aldrich,
The Causes of the Present Depression and
Possible Remedies,
pp. 10–11.

23Palyi, “The Meaning of the Gold Standard,” p. 304; Charles O. Hardy,
Credit Policies of the Federal Reserve System
(Washington, D.C.: Brookings Institution, 1932), pp. 113–17.

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The fountainhead and inspiration of the financial world of the 1920s was Great Britain. It was the British government that conceived the system of inter-central bank cooperation, and that persuaded the United States to follow its lead. Britain originated the policy as a means of (temporarily) evading its own economic dilemmas, yet proclaimed it in the name of “humanitarian reconstruction.” England, like the United States, also used cheap credit to lend widely to Continental Europe and thus promote its own flagging export market, hobbled by high costs imposed by excessive union wage rates.

In addition, Great Britain persuaded other European countries to adopt the gold exchange standard instead of the full gold standard, in order to promote its own “economic imperialism,” i.e., to spur British exports to the Continent by inducing other countries to return to gold at overvalued exchange rates. If other countries overvalued their currencies
vis-à-vis
sterling, then British exports would be bolstered. (Britain showed little concern that exports from the Continent would be correspondingly hampered.) The abortive and inflationary gold exchange standard permitted countries to return to gold (at least nominally) earlier and at a higher exchange rate than they otherwise would have essayed.24 Other countries were pressured by Great Britain to remain on the gold bullion standard, as she was, rather than proceed onward to restore a full gold-coin standard. To cooperate in international inflation, it was necessary to keep gold from domestic circulation, and to hoard it instead in Central Bank vaults. As Dr. Brown wrote: In some countries the reluctance to adopt the gold bullion standard was so great that some outside pressure was needed to overcome it . . . i.e., strong representa-tions on the part of the Bank of England that such action would be a contribution to the general success of 24“The ease with which the gold exchange standard can be instituted, especially with borrowed money, has led a good many nations during the past decade to ‘stabilize’ . . . at too high a rate.” H. Parker Willis, “The Breakdown of the Gold Exchange Standard and its Financial Imperialism,”
The Annalist
(October 16, 1931): 626f. On the gold exchange standard, see also William Adams Brown, Jr.,
The International Gold Standard Reinterpreted, 1914–1934
(New York: National Bureau of Economic Research, 1940), vol. 2, pp. 732–49.

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the stabilization effort as a whole. Without the informal pressure . . . several efforts to return in one step to the full gold standard would undoubtedly have been made.25

One important example of such pressure, joined in force by Benjamin Strong, occurred in the spring of 1926, when Norman induced Strong to support him in fiercely opposing a plan of Sir Basil Blackett’s to establish a full gold-coin standard in India.

Strong went to the length of traveling to England to testify against the measure, and was backed up by Andrew Mellon and aided by economists Professor Oliver M.W. Sprague of Harvard, Jacob Hollander of Johns Hopkins, and W. Randolph Burgess and Robert Warren of the New York Reserve Bank. The American experts warned that the ensuing gold drain to India would cause deflation in other countries (i.e., reveal their existing over-inflation), and suggested instead a gold exchange standard and domestic “economizing” of gold (i.e., economizing for credit expansion). In addition, they urged wider banking and central banking facilities in India (i.e., more Indian inflation), and advocated continued use of a silver standard in India so as not to disrupt American silver interests by going off silver and thus lowering the world silver price.26

Norman was grateful to his friend Strong for helping defeat the Blackett Plan for a full Indian gold standard. To the objections of some Federal Reserve Board members to Strong’s meddling in purely foreign affairs, the formidable Secretary Mellon ended the argument by saying that he had personally asked Strong to go to England and testify.

To his great credit, Dr. Hjalmar Schacht, in addition to opposing our profligate loans to local German governments, also sharply criticized the new-model gold standard. Schacht vainly called for a return to the true gold standard of old, with capital exports 25William Adams Brown, Jr.,
The International Gold Standard Reinterpreted,
1914–1934
(New York: National Bureau of Economic Research, 1940), vol. 1, p. 355.

26This is not to endorse the entire Blackett Plan, which also envisioned a £100

million gold loan to India by the U.S. and British governments. See Chandler,
Benjamin Strong, Central Banker,
pp. 356ff.

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financed by genuine voluntary savings, and not by fiat bank credit.27

A caustic but trenchant view of the financial imperialism of Great Britain in the 1920s was expressed in the following entry in the diary of Emile Moreau, Governor of the Bank of France: England having been the first European country to reestablish a stable and secure money has used that advantage to establish a basis for putting Europe under a veritable financial domination. The Financial Committee [of the League of Nations] at Geneva has been the instrument of that policy. The method consists of forcing every country in monetary difficulty to subject itself to the Committee at Geneva, which the British control. The remedies prescribed always involve the installation in the central bank of a foreign supervisor who is British or designated by the Bank of England, and the deposit of a part of the reserve of the central bank at the Bank of England, which serves both to support the pound and to fortify British influence. To guarantee against possible failure they are careful to secure the cooperation of the Federal Reserve Bank of New York.

Moreover, they pass on to America the task of making some of the foreign loans if they seem too heavy, always retaining the political advantage of these operations.

England is thus completely or partially entrenched in Austria, Hungary, Belgium, Norway, and Italy. She is in the process of entrenching herself in Greece and Portugal. . . . The currencies [of Europe] will be divided into two classes. Those of the first class, the dollar and the pound sterling, based on gold, and those of the second class based on the pound and dollar—with a part of their gold reserves being held by the Bank of England and the Federal Reserve Bank of New York, the latter moneys will have lost their independence.28

27See Beckhart, “The Basis of Money Market Funds,” p. 61.

28Entry of February 6, 1928. Chandler,
Benjamin Strong, Central Banker,
pp. 379–80. Norman did not insist on League of Nations control, however, when he and Strong agreed, in December 1927, to finance the stabilization of the Italian lira, by jointly extending a $75 million credit to the Bank of Italy ($30 million from the New York Bank), along with a $25 million credit by Morgan’s and an equal loan by other private bankers in London. The Federal Reserve Board, as well as Secretary Mellon, approved of these subsidies. Ibid., p. 388.

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The motives for the American inflation of 1924, then, were to aid Great Britain, the farmers, and, in passing, the investment bankers, and finally, to help reelect the Administration in the 1924

elections. President Coolidge’s famous assurance to the country about low discount rates typified the political end in view. And certainly the inflation was spurred by the existence of a mild recession in 1923–1924, during which time the economy was trying to adjust to the previous inflation of 1922. At first, the 1924 expansion accomplished what it had intended—gold inflow into the United States was replaced by a gold drain, American prices rose, foreign lending was stimulated, interest rates were lowered, and President Coolidge was triumphantly reelected. Soon, however, with the exception of the last-named, the effects of the expansion dissipated, and prices in America began to fall once more, gold flowed in heavily again, etc. American farm product prices, which had risen from an index of 100 in 1924 to 110 the year later, dropped back again to 100 in 1926. Exports for farm and food products, which had reached a peak during 1925, also fell sharply in the following year. In sum, the American economy entered into another mild recession in the fall of 1926, continuing on into 1927. Britain was in particularly bad straits, addicted to cheap credit, yet suffering chronic unemployment and continual drains of gold. But Great Britain insisted on continuing its policy of cheap money and credit expansion—an insistence of the British government rather than its private bankers.29