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BRITISH FINANCIAL WARFARE: 1929; 1931- 33
HOW THE CITY OF LONDON CREATED THE GREAT DEPRESSION
THE END OF THE WORLD
On Sunday, September 20, 1931, the British government issued its statements announcing its decision to "suspend for the time being" the clause of the Gold Standard Act of 1925 requiring the Bank of England to sell gold at the fixed price. All the other elements of the official British mythology were also present. "His Majesty's Government have no reason to believe that the present difficulties are due to any substantial extent to the export of capital by British nationals. Undoubtedly the bulk of withdrawals has been for foreign accounts." The bloody wogs, as we see, were once again the root of the problem.
Furthermore: "His Majesty's Government have arrived at their decision with the greatest reluctance. But during the last few days international markets have become demoralized and have been liquidating their sterling assets regardless of their intrinsic worth. In the circumstances there was no alternative but to protect the financial position of this country by the only means at our disposal." As we have seen, there were other means. Finally, there was the obligatory stiff upper lip: "The ultimate resources of this country are enormous and there is no doubt that the present exchange difficulties will prove only temporary." [New York Times, September 21, 1931]
The worldwide shock was severe. In the words of Jackson E. Reynolds. then President of the First National Bank of New York, "when England went off gold it was like the end of the world."
THE BANKERS' RAMP
With the help of demagogic headlines in the London afternoon tabloids, the British oligarchy placed the blame for the fall of the mighty pound on a "bankers' ramp" led by foreign central bankers. A favorite target was poor George Harrison of the New York Federal Reserve, who was rewarded with slander and obloquy for his pathetic and servile devotion to the currency of British imperialism. Another fall-guy was the Banque de France.
One British chronicler of these times sums up the official line of scapegoating the foreigners as follows:
"It was basically the American trade cycle, and not British monetary policy, that made life so wretched for us." [R.S. Sayers, 97]
JACQUES RUEFF ATTACKS BRITISH HANDLING OF CRISIS
During the weeks of the British crisis, the economist Jacques Rueff was serving as the Financial Attache at the French Embassy in London. This meant that Rueff was in practice the manager of the French sterling balances.
Palyi cites the "'posthumous' charge by Rueff that
the "Bank of England defaulted intentionally in order to damage the creditor central banks, the Bank of France in particular...." [Palyi, p. 268]
On October 1, 1931, Rueff completed his memorandum entitled "Sur les causes et les enseignements de la crise financière anglaise," which was intended to be read by French Finance Minister P.-E. Flandin and the French Prime Minister, Pierre Laval.
Rueff first described the modes of intervention of the Bank of England:
"Elle avait...deux instruments: le taux d'escompte et la politique dite d''open market'....Depuis 1929 la Banque d'Angleterre a constamment utilisé ces deux instruments pour maintenir aussi bas que possible les taux en vigeur sur le marché de Londres. Elle a toujours retardé aux maximum les élévations de taux d'escompte qui s'imposaient, cependant qu'elle cherchait à augmenter, par ses achats de valuers d'Etat, l'abondance monétaire du marche." [Jacques Rueff, De L'Aube au Crépuscule, p. 301]
For Rueff, the British were guilty of violating the implicit rules of the gold exchange standard, since they tried to maintain their liquidity despite a gold outflow.
"on peut affirmer notamment qu'en 1929 et 1930, presque sans exception, la politique d''open market' de la Banque d'Angleterre a été faite à contresens. Les mouvements d'or, en effet, tendent à se corriger eux-mêmes, puisque toute sortie de métal tend à provoquer une restriction de crédit, qui hausse les taux du marche. Or, en 1929 et 1930, toutes les fois que de l'or sortait de la Banque d'Angleterre, celle-ci achetait des valeurs d'Etat sur le marché, remplacant ainsi les disponibilites qui venaient de dispara&itremas;tre." [302]
"Autrement dit, pendant les deux années 1929- 1930, la Banque d'Angleterre a constamment paralysé le jeu des phénomenes qui tendaient à adapter la balance des paiements anglais aux nécessites résultant de la politique économique suivie par le pays." [p. 303]
Because of these policies, Rueff found, the British had weakened themselves even before the German crisis had begun: "Or, en 1931, ces fautes ont été commises, provoquant des mouvements de capitaux qui ont été mortels pour le change anglais. Il est très probable que l'Angleterre aurait pu y résister, si elle n'avait pas été mise préalablement dans un état de paralysie économique et financière, interdisant à son organisme les réactions spontanées d'un marche normal." [p. 303]
Rueff repeatedly condemns Stimson's intervention at the London Conference of July, 1931 with the proposal for standstill agreements which immediately created a liquidity crisis and put world banking in difficulty: "Toutes les banques du monde, voyant soudain immobilisé une fraction très importante de leurs capitaux a court terme, ont cherché à récupérer toutes les réserves qu'elles pouvaient rendre disponibles." [304}
But the British always blamed the wogs:
"...l'opinion britannique ...recherche a l'exterieur la cause de ses difficultés." [305]
The British had been wallowing in a depression since 1918, and that for them made it a world economic crisis:
"Il faut d'abord remarquer que, pour l'opinion britannique, la crise économique d'après guerre n'est pas chose nouvelle. Depuis que l'Angleterre souffre du chomage permanent - c'est- à-dire depuis la guerre - l'opinion britannique et les experts anglais affirment que le monde est en état de crise. Depuis la guerre, même lorsque le monde, sauf l'Angleterre, était en pleine prospérite, les représentants britanniques ne cessaient de demander à la Société des Nations de trouver un remède à la crise économique, qualifiée de mondiale parce qu'elle affectait les intérêts du Royaume-Uni de Grande-Bretagne et d'Irlande." [307]
A key British problem was their high unemployment, which they had chosen to deal with by means of payments to the unemployed, called the dole:
"Et cela explique que la hausse des prix soit pour l'Angleterre, dans le régime ou elle s'est volontairement placée, une nécessité vitale. Ayant fixe une catégorie des prix, elle est conduite à vouloir y adapter tour les autres....Cette hausse des prix anglais peut, il est vrai, être réalisée sans hausse des prix mondiaux, par la dépréciation de la livre sterling et aussi - bien que dans une mesure probablement insuffisante - par un tarif douanier. D'ou des diverses solutions envisagées en Angleterre, l'une d'entre elles - la dépréciation monétaire - étant déjà en voie de réalisation...." [308-309]
For Rueff, all British proposals for international monetary cooperation were strategems designed to shift the crisis from Britain to the rest of the world:
"Il reste enfin à évoquer la dernière des formules par lesquelles l'Angleterre prétend que le monde devrait etre reconstruit: la cooperation financière internationale. C'est là un programme dont le sens n'a jamais été défini, probablement parce qu'il n'en a aucun....Il n'est pas douteux que tous les plans présentés à Genève ou a Bale, plan Norman, plan Kindersley, plan Francqui, tendent seulement a réaliser le trust des entrprises en faillite et a y investir des capitaux qui sans cela se seraient refusés. Par là, ils sont un merveilleux instrument pour transférer les difficultes financières des Etats qui les ont provoqués, a ceux qui ont été assez sages ou assez prudents pour s'en préserver...Tel est d'ailleurs le sens profond et l'objet véritable de tous les efforts tendant a réaliser la solidarité internationale, solidarité que l'on invoque toujours lorsque l'on veut profiter de la prosperité des Etats voisins, mais jamais lorsque l'on peut leur venir en aide." [318-319]
Rueff suggested a Franco-American accord capable of putting an end to the British game.
THE BANK OF ENGLAND'S DUTCH TREAT
By September 20, most of the sterling balances held by foreigners who were disposed to liquidate them had already been liquidated. The exception were sterling balances held by foreign central banks, like the Dutch, and these would be loyal to London, partly because their estimate was that the crisis was not so severe as to force the British off gold. The little people of the British public were proving docile enough to make no attempt to turn in their pound notes for gold. The Big Five clearing banks were undisturbed by panic runs or the specter of insolvency.
There is no doubt that during the weeks before default, the Bank of England practiced the most cynical deception on other central banks. The Bank of England twice assured the Bank of South Africa that it would do everything in its power to maintain gold payments. The Bank of England acted with great treachery towards the Netherlands Bank, the central bank which had shown itself to be the truest friend of the pound, supporting it in crisis after crisis. The president of the Netherlands Bank, Mr. Vissering, telephoned the Bank of England on September 18, 1931 to enquire whether there was any truth to the rumors about a forthcoming sterling devaulation. The Bank of England official who answered the phone emphatically denied that there would be a devaluation, and offered to pay off the Netherlands Bank sterling balances in gold on the spot. The Dutch decided to keep their gold in London.
A few days after the call summarized above,
"Dr. G. Vissering of the Netherlands' Central Bank called Harvey to request that the Dutch gold held by the Bank of England be earmarked [separated from the Bank of England stocks as a preliminary to shipment to the Netherlands]. Harvey huffily refused, saying that the Dutch could either take their gold back to Amsterdam or keep it in London but if they chose the latter course they would not be placed in the position of a preferred creditor. Vissering backed down. To assuage Vissering's fears Harvey wrote him about the credits and stressed the total committment of the National Government to the maintenance of the gold standard [Kunz, pp. 119- 120] As a result, "the Netherlands Bank felt, and for good reason so, that it had been deceived by the Bank of England, a turn that was scarcely befitting Norman's idea of central bank cooperation, or the 'ethics' of the gold standard." [Palyi, p. 278]
The Netherlands Bank thought that the Bank of England should safeguard the Netherlands Bank against all the sterling losses to which it was subjected. A discussion of this British betrayal is found in the 1931-32 Annual Report of the Netherlands Bank. [see Brown, vol, 2, pp. 1170-1172]
Montagu Norman claimed that he had personally not been a participant in the decision to default on gold. As we have noted, Norman's cover story was that he had suffered a nervous breakdown, and had taken a vacation at the Chateau Frontenac in Quebec, Canada. When the Bank of England suspended gold payment, Norman was on board ship in the middle of the Atlantic. Norman claims that he knew nothing of the decision to go off gold until he landed at Liverpool on September 23. Norman was thus able to blame the default on one of his resident whipping-boys, Deputy Governor Sir Ernest Harvey. Harvey himself suffered a nervous breakdown because of the stress of serving under Norman.
When the British stopped paying in gold, they were quickly followed by Denmark, Sweden, Norway, Holland, Bolivia, and India - most of whom were candidates for inclusion in the sterling bloc. Other countries, including Greece, Italy, Germany, Austria, and Hungary were already operating under exchange controls and other measures which effectively prevented gold outflow. [Hoover, p. 82]
The British strategy for saving the golden pound had included histrionic international appeals from Prime Minister Ramsay MacDonald, who pleaded with other countries not to drain off the last of the British gold. After the British had defaulted, MacDonald's perfidy caused much resentment abroad. In the words of an American economist,
"Hardly had Ramsay MacDonald stopped sobbing over the international radio that Britannia should not be forced to sacrifice her honor, than he began to smile broadly because the fall of the pound gave her marked advantage in exports." [Mitchell, p. 14]
THE BRITISH GAME
A British estimate of the London predicament of the early 1930's reads as follows:
"...Great Britain is a highly populated industrial country, carrying a terrific burden of internal debt, dependent predominantly for existence on foreign trade, enjoying the benefits of being the world's chief banking centre, possessed of a large net income from long-term investments abroad, but heavily indebted (in her role as world's banker) to other centres on short- term account." [Economist, September 26, 1931, p. 548]
The British racket up until September 1931 had been to use a high pound to maximize their buying up of the world's productive assets and resources. After September, 1931, a devalued pound meant that pound-denominated foreign claims on the British financial system - and these were the vast majority - were automatically reduced.
Five months after the British default, Norman and the British oligarchy embarked on a policy of cheap money. At this time a series of Bank Rate reductions was started which soon brought the discount to 2.5%, where it stayed for many years. Montagu Norman himself, the former gold addict, became the main theoretician of Cheap Money in the new era of competitive monetary devaulations. The British stock market quickly recovered amd kept rising during most of the 1930's. But unemployment hovered around 2.5 million until the beginning of the Second World War.
"For years, Continental opinion had been coming to the view that the British system was dying of ossification," wrote Lionel Robbins [p. 93] "Now the British had increased their own relative importance compared to their continental rivals, who had joined them in perdition."
The post-1931 British strategy also included Imperial Preference and trade war:
"Britain entered the lists with the Import Duties Act of March, 1932 (reaching 33 1/3 per cent), and the later Ottawa Agreement establishing empire tariff preferences spurred other countries in the process of retaliation. Sterling losses of so many countries spread deflation through the struggle for liquidity. The contest between economies that remained on gold and those that had left it became acute." [Mitchell, p. 14]
Soon, US exports to the rest of the world had dropped to about one third of their 1929 level. [Hoover, p. 83] European purchases of American agricultural products ceased almost entirely. US unemployment increased rapidly. Tax revenue fell by 50%. [Hoover, p. 89]
BRITISH DEFAULT: TEN MORE YEARS OF WORLD DEPRESSION
The Gibraltar of British Empire finance had crashed. The old saying, "as safe as the Bank of England" was now a mockery.
"It was only vaguely understood, if at all, that at stake was what is called today the 'world monetary system.' It was still a sterling system. The likely alternative to...the gold standard, at the old sterling parity, may have been the breakdown of that system. That is what happened after September, 1931.' [Palyi, p. 86]
"The cooperation of the central banks in the 1920's ended in a breakdown of the entire system, having been essentially a cloak that masked the ultimate purpose of its chief ingredient, the gold exchange standard, which was to maintain Britain's gold standard without obeying the rules of the gold standard." [p. 146]
During the 18-month period after the British default, most world currencies also terminated gold payments through external default. Until March, 1933 the US dollar and some of its satellite currencies in central America were able to keep up payments on gold. Otherwise, the gold standard was maintained by a group of countries called the "gold bloc," comprehending France, Holland, Belgium, Switzerland, Italy, Poland, and Estonia. Estonia was forced off gold, and Italy and Poland imposed gold export controls. The Belgian franc was devalued in March, 1935. France imposed a gold embargo in September, 1936. Switzerland and Holland announced devaluations immediately thereafter.
Of the fifty-four nations that had been on the gold standard at some timne between 1925 and 1931, none remained on gold in 1937. The world monetary system had indeed disintegrated.
CHART: COUNTRIES LEAVING THE GOLD STANDARD
APRIL 1929 - APRIL 1933
1929
APRIL - URUGUAY
NOVEMBER - ARGENTINA
DECEMBER - BRAZIL
1930
MARCH - AUSTRALIA
APRIL - NEW ZEALAND
SEPTEMBER -VENEZUELA
1931
AUGUST - MEXICO
SEPTEMBER - UNITED KINGDOM, CANADA, INDIA, SWEDEN, DENMARK, NORWAY, EGYPT, IRISH ,FREE STATE BRITISH MALAYA, PALESTINE
OCTOBER - AUSTRIA ,PORTUGAL, FINLAND ,BOLIVIA, SALVADOR
DECEMBER - JAPAN
1932
JANUARY - COLOMBIA, NICARAGUA, COSTA RICA
APRIL - GREECE, CHILE
MAY - PERU
JUNE - ECUADOR ,SIAM
JULY - YUGOSLAVIA
1933
JANUARY - UNION OF SOUTH AFRICA
APRIL - HONDURAS, UNITED STATES
[See Brown, 1075]
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BEYOND BREAKDOWN TO DISINTEGRATION
The year 1931 is thus a turning point in the financial history of Europe analogous to 1914 in political-military history: "...because of the profound influence of the war upon the structure of the world's credit system and upon the economic environment in which it operated, 1914-19 was a period that marked the breakdown, rather than the suspension or modification, of the pre-war international gold standard system.......when England suspended the convertibility of sterling in 1931 the international gold standard as a world institution entered into an historical phase which must be described by a stronger term than breakdown. SEPTEMBER 1931 MARKED THE BEGINNING OF ITS DISINTEGRATION." [Brown, p. 1052, emphasis added]
Current historians and economists are fixated on 1929, but there can be no doubt that September 1931 was the more important watershed by far. "Britain's devaluation in 1931 had a psychological and political impact on Europe, and beyond, that can hardly be overestimated. In final analysis, the break-up of the international financial and commercial system was a decisive factor in balkanizing Europe and preparing the ground for World War II." [Palyi, p. 270] Another writer noted that among the "consequences [of 1931] were an increase of international suspicion and hatred, an inflamed nationalism in Europe and, finally, war." [Giuseppi, p. 164] Indeed.
CURRENCY BLOCS AND THE IMPULSION TOWARDS A NEW WORLD WAR
The scuttling of the pound-based, gold exchange international monetary system of the 1920's was perhaps the most potent underlying factor in the universal renewal of armed conflict that soon followed. When the pound fell, a series of currency blocs emerged somewhat along the prototype of what had emerged under the guidance of Norman and Schacht as the German mark area. These currency blocs included the British pound sterling bloc, the US dollar bloc, the gold bloc (which broke up, leaving a franc bloc along with some other shards), the Soviet ruble area, the Japanese yen zone. The currency chaos meant that there was no reliable means of settling commercial payments among these blocs. World trade atrophied. The situation was difficult for everyone, but it was worst for those blocs which had the greatest dependency on exports and on importing oil, metals, rubber, and strategic raw materials. The pound sterling, dollar, franc and ruble each had some raw materials backing. But the German mark, Japanese yen and Italian lira had virtually none. Each of these states embarked on an economic regime of autarky so as to conserve foreign exchange. For Germany, Italy, and Japan, aggressive territorial expansion towards possible sources of oil and metals became the only available surrogate for foreign trade. The ascendancy of fascism was favored in each case by the penury of world trade, and in each case the British stood ready to promote fascist leaders who would ruthlessly act out this logic, as exemplified by Montagu Norman's role as the premier international patron of Hitler and the Nazis, and as the point man for the pro- Hitler directives which were carried out by Sir Henry Deterding, Averell Harriman, and Prescott Bush.
BEGGAR-MY-NEIGHBOR
The British were aware at the time of the colossal magnitude of what they had wrought, and were certainly aware of how rival states might suffer far greater consequences than the British themselves: "The facts must be faced that the disappearance of the pound from the ranks of the world's stable currencies threatens to undermine the exchange stability of nearly every nation on earth; that even though London's prestige as an international centre may gradually recover from the blow which the sterling bill has received, banking liquidity throughout the world has been seriously impaired, much more so in other countries than this; that international trade must be temporarily paralysed so long as the future value of many currencies is open to grave uncertainty; and that, though the memory of the disastrous effects of post-war inflations should be a useful deterrent, there is an obvious risk lest we may have started an international competititon in devaluation of currencies motived [sic] by the hope of stimulating exports and leading to a tragic reversion to the chaotic conditions which existed five or six years ago." ["The End of an Epoch," London Economist, September 26, 1931, p. 547]
The entire edifice of world trade and world banking had imploded: "The sterling bill enters so deeply into the whole mechanism of international trade, and so many foreign banks, including central banks, have been accustomed to keep a large portion of their reserves in the form of sterling balances in London, that the shock caused by the depreciation of sterling to some 80 per cent. of its value has necessarily been profound....the depreciation of the pound means that the currency reserves of many countries which are kept in the form of sterling balances have been seriously impaired, and the pre-existing strain on the banking system of many centres is bound temporarily at least to be aggravated by the universal shock which confidence has suffered....By our action, the value of the legal backing of a number of currencies has suddenly shrunk." [Economist, September 26, 1931, pp. 550-551]
By October, Perfide Albion was positively gloating about the massive gold outflow from the United States, which many now considered on te verge of a dollar crisis: "The suspension also of the gold standard in Great Britain had three important results. Firstly, it gave a further shock to confidence. Secondly, it prevented foreign banks from drawing upon their sterling balances except at a heavy loss, and so drove them back on their dollar balances. Finally, it destroyed all faith in the safety and efficacy of the gold exchange standard, for foreign central banks found that the sterling exchange which they had legitimately held as part of their legal reserve had lost part of its value, thereby undermining their own stability, and inflicting upon them losses in many cases commensurate with their own capital." [London Economist, "America's Money Problems," October 10, 1931, p. 646] In other words, London's planned default had bankrupted a series of central banks who had deposited their reserves in the Bank of England.
A few weeks later, The Economist commented further: "It was inevitable that the suspension of gold payments in England should have a profound effect upon the position of leading central banks. Some who were engaged in operating the gold exchange standard were in possession of susstantial holdings of sterling as part of their legal reserve against their notes and other sight liabilities while others - such as the Banque de France - held equally large quanities of sterling, even though they were operating on the full gold standard. All these central banks have had to face a 20 per cent. depreciation of their holdings of sterling, which for many of them means a substantial proportion of their legal currency reserves.
"This situation has already had several far-reaching results. Many countries have summarily abandoned the gold exchange standard as a snare and a delusion, and their central banks have begun hurriedly to convert their devisen into gold. The general tendency has been to leave their sterling holdings intact, but to exchange their dollar balances and bills for gold; and this is a major cause of the recent efflux of gold from the United States. Again, commercial banks have not been immune from the consequences of the crisis, and have had to meet the suspicion and distrust of their customers. fostered by very numerous (if not individually very important) bank failures all over the world. They have had to face the immobilisation under the 'standstill' agreement of such part of their assets as they had ventured in Germany and central Europe; they have suffered, in common with the central banks, a 20 per cent. depreciation of their sterling holdings; and, last but not least, they have had to deal with the widespread dislocation to trade caused by the depreciation of sterling, which is the currency of world commerce. Thus commercial banks have, on the one hand, witnessed an outflow of notes into the hands of distrustful customers, and, on the other hand, they have had to mobilize their available assets, both at home and abroad, in preparation for further demands for currency." ["The Gold Rush," Economist, October 24, 1931, p. 746]
BRITISH DEFAULT PRECIPITATES US BANKING PANIC OF 1932-33
By August of 1931, Keynes estimated that commodity prices on the world market had fallen since 1929 by an average of 25%, with some commodities falling as much as 40 to 50%. Common stock shares had fallen worldwide by 40% to 50%, he reckoned. Investment-grade bonds were down by only 5%, but lower rated bonds were down by 10% to 15%, and the bonds of many governments had "suffered prodigious falls." When it came to real estate, the picture was more differentiated. Great Britain and France had been able to maintain relative firmness in real estate values, with the result that "mortgage business is sound and the multitude of loans granted on the security of real estate are unimpaired." The worst crash of real estate prices had occurred in the United States, Keynes found. Farm values had suffered a great decline, and newly developed urban commercial real estate was depressed to 60% to 70% of its cost of construction, and often less. Finally, Keynes estimated that the commercial loan portfolios held by banks were in the worst shape of all. Keynes evaluated this 2-year collapse as the worst world-wide deflation in the money values of real assets in history. [Essays in Persuasion, pp. 172-175]
Keynes pointed especially to something far worse yet to come, namely the potential world banking crisis that was implicit in the price collapses he had summed up. He concluded that in most of the non-British world, if bank assets were conservatively re-evaluated, "quite a significant proportion of the banks of the world would be found to be insolvent; and with the further progress of Deflation this proportion will grow rapidly." London had the least to worry about, since "fortunately our own domestic British Banks are probably at present - for various reasons - among the strongest." Once again the Americans would bear the brunt of the crisis:
...in the United States, the position of the banks, though partly concealed from the public eye, may be in fact the weakest element in the whole situation. It is obvious that the present trend of events cannot go much further without something breaking. If nothing is done, it will be amongst the world's banks that the really critical breakages will occur.
["The Consequences to the Banks of the Collapse of Money Values," (Aug. 1931) in Essays in Persuasion, p. 177]
During October, 1931, the British default had provoked a flurry of bank failures worldwide:the Comptoir Lyon-Alemand closed; Handels Bank of Denmark needed to be bailed out by central bank, the Bank fuer Handel und Gewerbe, Leipzig, suspended payment, as did the Dresden Volksbank, the Franklin Trust Company of Philadelphia and 18 smaller US banks.
The central banks were so strapped for cash that there was a run on the Bank for International Settelements, which had to sell great masses of its own assets assets in order to meet the cash demands of its members, the central banks.
KEYNES: THE CURSE OF MIDAS
Keynes was very explicit that the most destructive consequences of the British default were going to be visited upon the United States, which was still on the gold standard:
"...the competitive disadvantage will be concentrated on those few countries which remain on the gold standard. On these will fall the curse of Midas. As a result of their unwillingness to exchange their exports except for gold their export trade will dry up and disappear until they no longer have either a favourable trade balance or foreign deposits to repatriate. This means in the main France and the United States. Their loss of export trade will be an inevitable, a predictable, outcome of their own action. [...] For the appreciation of French and American money in terms of the money of other countries makes it impossible for French and American exporters to sell their goods. [...] They have willed the destruction of their own export industries, and only they can take the steps necessary to restore them. The appreciation of their currencies must also gravely embarrass their banking systems. ["The End of the Gold Standard, (Sept. 27, 1931) in Essays in Perusasion, pp. 292-293]
One possible outcome contemplated with eager anticipation by London was that the gold outflow experienced by the United States after the British default would lead to the short-term collapse of the US dollar. By law, the Federal Reserve in those days had to have sufficient gold to cover 40% of the value of all outstanding Federal Reserve dollar notes. At first glance, that 40% of Federal Reserve notes might have seemed to set the minimum gold stock necessary for the survival of the dollar in its then-current form. But in reality the gold requirements of the US were far greater, precisely because of the ongoing economic depression. The London Economist was aware of this grave vulnerability of the American currency:
"The real crux of the Reserve system's position is that, while the ratio of the gold cover to its notes need be only 40 per cent., the remaining 60 per cent. of the notes must be covered either by gold or by eligible paper, and this last excludes Government securities bought in the open market, and in practice consists of rediscounted Treasury bills and also of acceptances and other credit instruments based upon trade. Now the depressed state of trade has reduced the Reserve Banks' holdings of assets of this last kind and has forced then en defaut de mieux to add enormously to their holdings of Government securities. The actual figure for the last-named was $728 millions last August, against only $150 million two years before, while during the same period 'eligible paper' had fallen from $1.141 to $316 millions. Add to this the actual and potential increase in the note circulation, and it is clear that this is the major factor in any calculation of the minimum gold requirements of the United States." [Economist, October 10, 1931, p. 647]
THE BRITISH CAST THE CURSE OF MIDAS ON AMERICA
In the event, the impact of the British gold default of Sept. 21, 1931 on the United States banking system was nothing short of catastrophic. Within six weeks, the United States was drained of about $700,000,000 worth of gold. "The rush from abroad to convert dollar balances into gold frightened American depositors, and they began to withdraw currency from their banks." [Kennedy, p. 30] Bank withdrawals were $400,000,000 during these same six weeks [Mitchell, p. 128]. By November, "almost half a billion dollars had gone into hiding," - meaning hoarding, with individuals putting their cash in a safety deposit box, mattress, or old sock. [Kennedy, p. 30]
As soon as the British had carried out their own default, the attention of the City of London turned to the potential for an outflow of American gold: "...Wall Street generally has stood up well to the shock. It would be premature, however, to jump to the conclusion that the full eventual repercussions have yet begun to be experienced in the United States. For one thing, the volume of short-term credits held by France, Holland, and other European countries in New York is very great, and it is significant that already gold in large sums has begun to be withdrawn on foreign account from the Federal Reserve system." [Economist, September 26, 1931, p. 550]
Within just a few weeks, the US gold hemorrhage had become so serious as to threaten the gravest consequences: "The present crisis resembles the onslaught of a thunderstorm in a mountain range, when the lightning strikes first one peak and then a neighbour....Now it is apparently the turn of the United States, for in the middle of September a drain of gold began on a scale comparable only with the gold losses incurred by Germany and Great Britain in earlier months....the total loss is indicated by the contraction of $449 millions in the Federal Reserve Banks' gold reserve between September 17th and October 8th." [Economist, October 10, 1931, p. 646]
And: "It is true that in certain respects the American banking position has been arousing misgivings. The increase in the note circulation shows that hoarding is definitely taking place, and this hoarding is evidence of public distrust in the stability of American banks. The steady stream of bank failures corroborates this. Again, it is realised that depressed trade, and the collapse of security and real estate values during the past two years, has undermined the value of banking collateral and impaired the liquidity of the banks. Still, allowing for these somewhat ominous signs, it is probably true to say that the need of foreign banks to strenghten these home resources was a more cogent cause of the withdrawals." [Economist, October 10, 1931, p. 646]
The Economist was also busy calculating the point at which financial necrosis would set in:
"...the United States could, at last gasp, part with $1,700 millions of gold, though the National City Bank very pertinently calls this a theoretical maximum." "A rough calculation, however, shows that European central banks together still hold foreign exchange equal to some $1,400 millions." [Economist, October 10, 1931, p. 646]
In 1928, there had been 491 US bank failures. In 1929, the figure had risen to 642. By 1930, as the collapse of the domestic real estate bubble began to take its toll, bank failures had risen to 1,345. In the wake of the British default, American "bank runs and failures increased spectacularly: 522 commercial banks with $471 million in deposits suspended during October 1931; 1,860 institutions with deposits of $1.45 billion closed between August 1931 and January 1, 1932. At the same time, holdings by the 19,000 banks still open dropped appreciably through hoarding and deterioration of their securities." [Kennedy, p. 30] Thus, the disintegration of the London gold standard represented a qualitative turning point in the development of the US banking panic. In terms of individual bank failures, 1931, the year of the British default, was the worst year in American banking history.
The decisive role of the pound sterling crisis in detonating the domestic US banking panic is stressed by another chronicler of the Great Depression: "...in all of 1931, a peak number of 2,298 banks with deposits of $ 1.692 billion succumbed to insolvency. As we have seen, about three quarters of these failures came during or after the British crisis, and the vast majority of the damage to the depositors ($1.45 billion out of $ 1.692 billion) was inflicted during and after the London default." [Mitchell, p. 128]
The shock waves from the London default were felt first and most severely among the American banks of Chicago, Ohio, and other parts of the Midwest, followed by Pennsylvania, New York, and then New England.
The US banking system was now being subjected to the kind of speculative attack foreshadowed by the analysis of Lord Keynes. While some of the demands for gold were coming from France, it is evident that a very large proportion were coming from London, whether directly or indirectly. This was an attack which the Anglophile Hoover, deluded by his personal meeting with Ramsay MacDonald, was ideologically incapable of understanding.
It was in October, 1931 that Hoover broke his long immobilism on the banking question and launched the ill-starred National Credit Corporation, his unsuccessful public-private partnership to bail out the banks. This timing shows that in Hoover's view as well, the London default had been a major milestone on the road to US banking panic.
On the evening of October 6, 1931 Hoover met with 32 Congressional leaders of both parties at the White House. Hoover summarized the world economic situation in the wake of the British default:
"The British... are suffering deeply from the shocks of the financial collapse on the Continent. Their abandonment of the gold standard and of payment of their external obligations has struck a blow at the foundations of the world economy. The procession of countries which followed Britain off the gold standard has left the United States and France as the only major countries still holding to it without modification. The instability of currencies, the now almost world-wide restrictions on exchange, the rationing of imports to protect these currencies and the default of bad debts, have cut deeper and deeper into world trade."
Hoover was forced to concede that the once-prosperous US had been dragged down to the same wretched level as the chronically depressed British: "We are finding ourselves in much the same position as the British, but in lesser degree. Long-term loans which we made to Europe and the mass of kited bills bought from them are affecting us sadly with each new default. Like the British, we too are increasingly unable to collect moneys due us from abroad. Extensive deposits in our banks owned by foreigners are demand liabilities on our gold reserves and are becoming increasingly dangerous. After the British abandoned the gold standard, even the dollar came under suspicion. Out of an unreasoning fear, gold is being withdrawn from our monetary stocks and bank reserves. These devitalizing drains and the threat of them hang like a Damoclean sword over our credit structure. Banks, fearing the worst, called in industrial and commercial loans, and beyond all this the dwindling European consumption of goods has decreased purchases of our farm products and other commodities and demoralized our prices, production, and employment. We are now faced with the problem, not of saving Germany or Britain, but of saving ourselves." [Hoover, p. 90]
A day earlier, in a letter to George Harrison at the New York Federal Reserve, Hoover had described the problems created by the British crisis for the individual American banker: "There have been in some localities foolish alarms over the stability of our credit structure and considerable withdrawals of currency. In consequence, bankers in many other parts of the country in fear of such unreasoning demands of depositors have deemed it necessary to place their assets in such liquid form as to enable them to meet drains and runs. To do this they sell securities and restrict credit. The sale of securities demoralizes their price and jeopardizes other banks. The restriction on credit has grown greatly in the past few weeks. There are a multitude of complaints that farmers cannot secure loans for their livestock feeding or to carry their commodities until the markets improve. There are a multitude of complaints of business men that they cannot secure the usual credit to carry their operations on a normal basis and must discharge labor. There are complaints of manufacturers who use agricultural and other raw materials that they cannot secure credits beyond day to day needs with which to to lay in their customary seasonal supplies. The effect of this is to thrust back on the back of the farmer the load of carrying the nation's stocks. The whole cumulative effect is today to decrease prices of commodities and securities and to spread the relations of the debtor and the creditor." [Hoover, p. 87]
On February 7, 1932, Secretary of the Treasury Ogden Mills informed Hoover that the United States was about two weeks away from defaulting on gold payment because of the continued flow of gold out of this country. To this had to be added the dwindling gold stocks of banks, which generally stood ready to convert paper money into gold when depositors asked for it. This gold disappeared domestically as it was added to private hoards.
In principle, the end of the gold standard at this time would have been a blessing in disguise. But given the laissez-faire obsessions of the Hoover administration, it is possible that such a move, especially if carried out in isolation from a general policy reversal in the form of a recovery program, would have engendered chaos. Hoover dodged the main issues by getting the Congress to allow the Fed to use more US Treasury securities in place of part of the gold. With this, the immediate post-British-default gold shortage was averted.
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© 2007 Webster G. Tarpley
SOURCE: http://www.tarpley.net/29crash.htm
