Ahamed profiles four central bankers who defined monetary policy in the decade leading to the 1929 crash. Montagu Norman, the Governor of the Bank of England; Benjamin Strong of the New York Federal Reserve Bank; Hjalmar Schacht of the Reichsbank; and Émile Moreau of the Banque de France. While their personalities played a role, far more important was their adherence to the gold standard which straitjacketed their banks culminating in the Great Depression. German reparations for WWI were problematic, but it was the restraints of the gold standard coupled with a reluctance of governments to interfere with market forces that doomed the world to depression. Well written and informative, I enjoyed this book and recommend it to those with an interest in economics, monetary policy and the depression. My blow by blow account below will give those interested a fair representation of what Ahmed covers, although Ahmed does it with considerably more style.
WWI devastated the economies of Europe and transferred world economic leadership from London to New York. In order to support the war England borrowed heavily from the US. France borrowed from both Britain and the US. Germany without other resources simply printed money. The Versailles Treaty called for Germany to pay huge reparations to Britain and France. Germany, essentially bankrupt, could not pay. The US expected repayment of its loans from England and France which they could not pay without the reparations from Germany. Britain and France tried unsuccessfully to link the amount they received from Germany to the amount paid to the US. The US would have none of it. Perceptive financial leaders saw that if this situation were to continue Europe would never recover and Germany could become chaotic. To pay reparations Germany printed more money causing runaway inflation. By 1923 German pay scales and prices changed daily. Anything earned had to be spent immediately before it lost its value. There was tremendous resentment in Germany for having to pay reparations to its conquerors. In turn France and England resented the US for its firm stance on loan repayment. They felt America did not appreciate that they had sacrificed millions of lives to protect the world from the Kaiser.
Before the war, the major participants were all on the gold standard. The amount of currency in circulation was determined by the amount of gold in the central bank based on its exchange rate. During the war the Europeans desperate for cash began printing money not backed by gold. This, exacerbated by the scarcity of items for purchase, led to inflation and devaluation of the currencies. The US had a different problem. It accumulated vast quantities of gold from Europe in payment for war supplies. Abiding by the gold standard meant that more currency had to be issued even though the goods available for purchase were not increasing in proportion. Thus inflation occurred in America too. This was tempered by the beginning of Open Market Operations, the Feds buying and selling of securities to increase or contract the money supply. In this case they sold securities to pull in currency from circulation. This innovation was the brainchild of Benjamin Strong who had come from the House of Morgan. A devoted civil servant Strong took it upon himself to meet European financial leaders including Montagu Norman. If not for Strong’s new idea, inflation in the US would have gotten much worse. Today the Fed relies on Open Market Operations as a primary tool to control the value of the dollar.
In 1923 a new German government led by Chancellor Gustav Stresemann brought Hjalmar Schacht into the Treasury Department as currency tsar. This position was created to administer a new currency, the Rentenmark, based on the value of German land which the government could tax. The Reichsbank was still printing the Reichsmark by the wagonload. Schacht however pegged the value of his currency to that of the prewar mark and with great discipline held it there. Once everyone realized the Rentenmark was stable it soon replaced the old currency. In 1924 Schacht took over at the Reichsbank with Germany’s inflation problem solved. Now a hero at home he still had the problem of reparations.
Schacht went to London to meet with Norman and boldly proposed that the Bank of England lend Germany money to pay reparations which would send the money back to Britain. The pound would be used as backing for German currency. This part impressed Norman who was trying to restore the pound’s position as a reserve currency. Perhaps more important Schacht impressed the Dawes Committee. Dawes was assigned by President Harding to lead an international committee to resolve the reparations issue. But it was another American, GE Chairman Owen Young, whose ideas led to a resolution. Realizing that they could not get agreement to lower the total amount of reparations he proposed that the amount of payment for the next several years be lowered to a more reasonable level ignoring the total amount due. Further he proposed that American banks loan Germany the money for the first year’s payment. The banks would be guaranteed that repayment of their loans had priority over reparations. The idea was to give the German economy time to recover so it could meet its obligations. With the guarantee US banks saw this as a profitable venture and it began a cycle of American lending to Germany. Dawes was rewarded by becoming Calvin Coolidge’s VP.
In 1925 England returned to the gold standard in what Churchill, the newly appointed Chancellor of the Exchequer, would much later call, “the biggest blunder in his life”. Urged on by Strong with whom Norman had recently met in New York, Norman pushed the gold standard on Churchill as a way to keep the currency from being manipulated for political reasons. Churchill understood little about economics and had to rely solely on the opinions of others. Keynes told Churchill to stay off the gold standard saying it would tie Britain to America where all the gold was, force unemployment, lead to high interest rates and bring down the English economy. Churchill sided with Norman. Keynes was right.
In France in 1926, the franc began to stabilize. This was due to Moreau who was brought in as Governor of the Banque de France that year. More political than economic expert, Moreau, unlike Churchill, heeded the right advice, which called for a lower but controlled value for the franc. This reduced the amount of the French debt. Unlike Germany where inflation wiped out all debt ruining its middle class, or England where Norman maintained a high value for the pound that brought recession, the French positioned the franc in the middle. Finding the sweet spot and keeping it there with purchases and sales of foreign currencies, Moreau brought France prosperity.
Back in the US, Strong’s innovative monetary policy helped keep inflation low and interest rates low at the same time the economy was robust due to growth in automobiles, radios and appliances. By 1926 many became concerned that the stock market might be entering a bubble. Given solid industrial growth, stock valuations were not yet out of line. However, low interest rates did facilitate a growing trend to take out loans to buy stocks. Strong did not see the stock market as the Feds concern, but he was concerned about the increasing number of loans going to Germany which were often spent on projects of little economic value. American bankers chasing profits bent over backwards to provide Germany loans. Germany prospered and accumulated too much debt for its creditors to let it fail. In 1927 Strong invited his counterparts, Norman, Schacht and Moreau, to New York. Moreau sent his economic expert, the English speaking Charles Rist. Schacht concurred in the fear of possible bankruptcy from the high amount of German debt. Norman was worried about the impossibility of maintaining the value of the British pound tied to the gold standard given Britain’s weak economy. Only Rist in France was satisfied with his situation. Following the meeting Strong decided against much internal dissension to lower US interest rates thus deferring to Norman to strengthen the pound. Strong ignored that lowering interest rates fueled speculation in the stock market which was now poised to head from reasonable valuations to stratospheric ones.
In 1928 Strong, who had a long history of tuberculosis, unexpectedly died in surgery. By this time, many in government and at the Fed including Strong’s successor, George Harrison, realized stock market speculation was leading to disaster. Harrison raised interest rates but the horse was out of the barn. Norman even came to the US to lobby Harrison for a further, albeit temporary, rate increase to slow the market down. Norman saw the US stock market as a greater risk to Britain than loss of value of his beloved pound. But the Fed was constrained. Raising rates further would hurt American farmers who were already suffering as credit was being diverted to Wall Street. The Fed also feared forcing Britain off the gold standard. However interest rates were high enough with the stock market eating up much of the available credit that reasonable long term loans to Germany stopped. So called “hot money”, short term loans at high rates, were available and Germany took them. With Germany now heading into recession and facing financial disaster a meeting was held in Paris in 1929 with Schacht, Moreau, Owen Young for the Americans and Sir Josiah Stamp of the original reparations commission for the British. Schacht proposed reduced reparations payments given Germany’s fragile situation. Moreau felt Germany had enough time to get its act together and Germany should resume full payments. After much drama, Schacht agreed to allied terms for reparations payments but the underlying worldwide credit issues were not dealt with at all. As the US stock market sucked up all credit, not just US farmers, but farmers worldwide faced depression taking down countries from Australia to Canada to Argentina. Even worse was that gold was leaving European central banks for America to feed the beast of Wall Street. With their currencies tied to the gold standard the Europeans had to raise interest rates turning their economies first to recession then depression. In August of 1929 the Fed raised its discount rate to stem the market bubble with little impact, but in Britain, now in a deep recession, this exacerbated the drain of gold leaving Norman to face the prospect of abandoning the gold standard and loss of faith in the pound.
In the fall of 1929, the stock market crashed quickly losing 40% of its value. Harrison bought treasuries to inject money into the banking system. By the summer of 1930 he had purchased $500 million and had prevented bank failures. He also lowered interest rates. Still the economy deteriorated, although as Ahmed notes the US had actually entered a recession before the crash. Still Ahmed credits the psychological impact of the crash as a primary factor leading to the depression. My own take is that other factors may have been more important. Kennedy in Freedom From Fear points out that income inequality left most people with little to spend and in debt to the hilt causing a recession before the crash. And as Ahmed did mention farmers had been in a depression for years before the crash. The stock market crash did dry up credit which particularly hurt Germany which could not meet its payments including to its many US creditors. The impact of this would kick in later forcing a depressed economy deeper into depression when the US government did not support at risk banks.
In 1930 the Bank of the United States, a private institution, became the first major bank to fail. Soon other banks began to follow suit as people pulled deposits and banks called in loans to boost reserves in a downward spiral. But tight credit caused even greater havoc overseas. Germany could not even pay its government workers without fresh loans which were near impossible to get. Then the 1930 election in which the Nazi’s became the second most powerful party in the Reichstag scared investors and capital flew out of the country. Britain’s strict adherence to the gold standard already bringing it a deep recession now headed into depression as credit dried up. Only France where the gold standard was mitigated by Moreau’s deft currency manipulations was prospering. In May 1931 Austria’s largest bank, Credit Anstalt, failed. This set off a loss of confidence across Germany as well as Austria leading to bank runs and more capital fleeing the country. Attempts by the US to stem the tide with a debt moratorium, which the French after much delay reluctantly agreed to, were too late. Major German corporations and banks failed and the banks were closed. Marks were no longer honored abroad and one-third of able bodied Germans were unemployed. Schacht who had alienated his political supporters with emotional tirades and resigned his position a year earlier now warmed up to the Nazis.
In 1931 Britain finally went off the gold standard. After exhausting all sources of loans, Britain realized the game was up. The pound depreciated 30% but now deflation was halted and recovery could finally begin. Next the US came under pressure as panicky holders of dollars suspected the US was next and began demanding their gold. By 1933, the New York Fed’s gold was totally depleted and it could no longer support the dollar. Bank runs had ensued all over the country and as FDR was inaugurated many states had instituted bank holidays. Unemployment was at twenty five percent and industrial output was in a tailspin with steel production at 12% of capacity. Prices had fallen 30%. The chaos of Europe in the prior year had now overtaken the US. FDR acted quickly taking the US off of the gold standard and even purchasing gold to further devalue the dollar. Prices rose, interest rates were low, it again became smart to borrow, the money supply increased, stock prices went up, and by the end of FDR’s first term industrial production doubled and GDP increased 40%.
Schacht became Hitler’s Minister of Economics and Reichsbank president in 1934. While giving lip service to the gold standard, he issued alternative currencies expanding the money supply, stopping deflation and financing Hitler’s industrialization and militarization. Schacht objected to the maniacal focus on rearmament while consumer goods were still expensive and often not available. He also was put off by the virulent anti-Semitism. In 1937 Goering forced him out of office. He was tried at Nuremberg but acquitted since he was not in office during the war. He died in 1970 at the age of 93. Norman remained as Governor of the Bank of England but with reduced influence and died in 1950. Moreau who left the Banque de France in 1930 for better paying private positions, also died in 1950. Harrison went on to the Manhattan Project authoring the famous cable to Truman at the Potsdam Conference announcing the success of the first atom bomb. He died in 1958.