Moreau, on the other hand, had just weathered a decade of high inflation, which he did not wish to risk repeating by easing credit. He insisted that under the rules of the gold standard, he had the complete right to convert his sterling holdings into bullion, and should this put Britain’s reserves under pressure, the Bank of England could always raise rates.
Quite aware that too precipitate an action by the Banque de France would threaten the Bank’s ability to keep the pound on gold, he tried to reassure Norman that he had no intention of destabilizing the gold standard or trying to undermine sterling, declaring melodramatically, “I do not want to trample on the pound.” Both parties claimed to be committed to the game, but each was adamant that it was the other who was not following the rules.
The British were not completely on the defensive. They did point out that while France held some $350 million in sterling that it could convert into gold, the British government held $3 billion of French war debts on which it could theoretically demand immediate repayment. The meeting closed in an inconclusive truce. In the following weeks, both sides somewhat halfheartedly backed down, the Bank of England allowing rates in Britain to rise modestly and the Banque de France engineering a fall in its rates. For the moment, outright financial conflict had been averted.
Schacht, Strong, Norman, and Rist on the Terrace at the New York Fed, July 1927
15. UN PETIT COUP DE WHISKY
1927-28
Not every mistake is a foolish one.
—CICERO
By THE END of 1926, this quartet of central bankers had already begun to worry about three of the factors—the U.S. stock market bubble, excessive foreign borrowing by Germany, and an increasingly dysfunctional gold standard—that would eventually lead to the economic upheaval at the end of the decade. None of them, however, yet anticipated the scale of the coming storm. Hjalmar Schacht was locked in combat with his own government; Montagu Norman and Émile Moreau were squabbling with each other; and Benjamin Strong was, as always, battling on two fronts—with his health and with his colleagues within the Federal Reserve System.
In 1926, after almost two years without an attack of tuberculosis, Strong developed pneumonia on his return from his summer in Europe. While lying sick with the new disease, at one point close to death, he was again scarred by personal tragedy, this one carrying with it a hint of scandal.
Confined to the Cragmore Sanatorium at Colorado Springs in 1923, he had struck up a friendship with another tubercular patient, Dorothy Smoller, a twenty-two-year-old actress from Tennessee. She had once been a dancer with Anna Pavlova’s ballet company, had had several parts on Broadway, and had even had a bit part in a movie. After a few months in the sanatorium, her money had run out and Strong and some other rich patients stepped in to support her. In November 1926, she resurfaced in New York, to be treated by Dr. James Miller, a Park Avenue physician and Strong’s personal doctor—like most tuberculosis patients, she had not fully shaken off the disease. She had just landed a part in another Broadway play when on the morning of December 9, after receiving a mysterious letter that reportedly distressed her, she killed herself by drinking a bottle of liquid shoe polish.
By her bedside were three letters, one for her mother in Long Beach, California, one for a friend, and one for Strong. She left instructions that the photograph of Strong in her possession be returned to him. No one can know whether she and Strong were romantically involved. Perhaps she was just a lost and unhappy young woman, a victim of the Broadway version of the boulevard of broken dreams, who had developed a fixation upon a distinguished and kindly man who had helped her. Whatever the case, her suicide, with its echoes of his wife’s death twenty years earlier, must have shaken him profoundly.
In December, he again left New York to recuperate, for a few weeks at the Broadmoor Hotel in Colorado Springs and thereafter in North Carolina. He returned to work six months later, in May 1927, to find the strains and stresses within Europe again building. The quarrel between Moreau and Norman was threatening to derail the pound, and had the potential to undermine the stability of the entire structure of the worldwide gold standard. Meanwhile, Schacht was beginning to clamor for some sort of international initiative to control the flow of foreign money into Germany, which, he feared, would never be able to repay all of its various accumulating debts.
Strong had always hoped that once the other major countries were back on gold, the lopsided maldistribution, which had left so much of the world’s gold stock in the United States, would correct itself. But that had not happened. Sterling had returned to gold at an unrealistically high exchange rate, leaving British goods expensive and difficult to sell in the world market. France, on the other hand, had done exactly the opposite. By pegging the franc at 25 to the dollar, the Banque de France had kept French goods very cheap. France was therefore in a position to steal a competitive edge over its European trading partners, particularly Britain. While this discrepancy between British and French prices persisted, the tensions could only fester. There was a natural tendency for money to move from overpriced Britain to underpriced France. To correct the situation, either prices had to fall further in Britain—which the authorities were trying to bring about without much success—or rise in France—which the Banque de France would not permit. The only alternative was to change the gold parity of sterling. But everyone feared that such a devaluation would so shock the banking world as to undermine any hope of order in international finances and even destroy the gold standard.
The Germans had avoided the British mistake. At the exchange rate of 4.2 marks to the dollar set by Schacht back in late 1923, German goods were cheap. Germany had a different problem. It had been denuded of gold during the nightmare years of the early 1920s and was now spending so much on reconstruction and reparations that, despite its large foreign borrowing, it was unable to build up new reserves. Thus, of all the countries in Europe, only France had enjoyed any success in attracting gold, although even this had been done, not so much by drawing gold from America as by weakening the position of Britain.
There was one way for the Fed to help Europe out of these dilemmas, or at least buy it some time. It could lower its interest rates further. In addition to giving Britain some breathing room, there were good domestic reasons to justify such a cut. Prices around the world were falling—not precipitously, but very gradually and very steadily. Since 1925, U.S. wholesale prices had fallen 10 percent, and consumer prices 2 percent. The United States had also entered a mild recession in late 1926, brought on in part by the changeover at Ford from the Model T to the Model A. The two main domestic indicators that Strong had come to rely on to guide his credit decisions—the trend in prices and the l
evel of business activity—argued that the Fed should ease. But interest rates at 4 percent were already unusually low.
Ever since the early 1920s when he had embarked on his policy of keeping interest rates low to help Europe, a faction within the Fed, led by Miller, had argued that Strong was too influenced by international considerations and especially by Norman. During Britain’s return to gold in 1925, he had been accused by some members of the Board of having exceeded his authority in providing the line of credit to the Bank of England. But at the time, there had been so much support within U.S. financial circles for Britain’s return to gold, and when the British did not even have to draw on the line of credit, the dissenting voices had died away. In 1926, while Strong was in France, he was again criticized by Board members for freelancing and acting too much on his own initiative. He responded that unless they were willing to come to Europe as frequently as he did, and familiarize themselves with the people and the situation, they would just have to trust him. While he did not shy away from conflict—quite the contrary, according to one colleague he seemed to “thoroughly enjoy getting into a fight and coming out on top”—the constant sniping over international policy became so wearing that he even threatened to resign.
The same faction that had opposed him on Europe had pressed him to tighten in 1925 and 1926 to bring down equity prices. While they had then sounded a false alarm on a bubble in stocks, with the market still strong—the Dow was hovering close to 170—he knew that were he now to loosen monetary policy to bail out the pound, he risked severely splitting the Fed.
In the summer of 1927, still weak from his recent illness, Strong decided that rather than go to Europe as he usually did, he would invite Norman, Schacht, and Moreau to the United States.39 Before the war, when the gold standard had worked automatically, the system had simply required all central banks, operating independently, to follow the rules of the game. Collaboration had not needed to go beyond occasionally lending one another gold.
Ever since the war, as the gold standard had been rebuilt and evolved into a sort of dollar standard with the Federal Reserve acting as the central bank of the industrial world, Strong had found it useful to consult frequently with his colleagues—he generally used his summers in Europe as an occasion to meet all of his European counterparts. This had begun with his getting together with Norman very informally and with minimum publicity once or twice a year—meetings of two friends who agreed on most essentials. After the stabilization of the mark in 1924, Schacht had joined the club, and the three of them convened in Berlin in 1925 and at The Hague in 1926. He now proposed a meeting of all four central banks, including the French.
Moreau, who spoke no English and feared being excluded from the most important discussions, decided to send his deputy governor, Charles Rist, in his place. Norman and Schacht traveled across the Atlantic together on the Mauretania, arriving on June 30. They took the usual precautions—their names did not appear on the passenger list and even their baggage was unmarked. But news of the meeting had leaked well in advance and the usual posse of reporters was waiting for them at dockside. Norman, nervous that Rist had arrived two days earlier and might have stolen a march on him, insisted on going straight from the ship to the downtown offices of the New York Fed.
Over the years, each of the central banks had acquired its distinctive architectural signature, somehow expressive of the institution’s character. While the Bank of England, for example, looked like a medieval citadel, the Banque de France like an aristocrat’s palace, the Reichsbank like a government ministry, for some reason—perhaps in a salute to those first international bankers, the merchant princes of Renaissance Italy—the New York Federal Reserve had chosen to dress itself up as a Florentine palazzo. With its ground-floor arches, heavy sandstone and limestone walls pierced with rows of small rectangular windows, and loggia gracing the twelfth floor, it was an almost exact imitation, on a grander and more epic scale, of the Pitti or the Riccardi palaces in Florence.
It was on the twelfth floor of this faux Italian palace that the four great banking powers of the world first convened. That weekend, however, desperate to get away from the prying eyes of the press, they moved in great secrecy to an undisclosed location out of the city. Strong had chosen for their clandestine meeting the summer home of Ogden L. Mills, undersecretary of the treasury. In an administration whose secretary of the treasury, Andrew Mellon, was the third richest man in the United States, it was in keeping that his deputy should be the heir to a robber baron fortune. Ogden Mills was, however, by the standards of third-generation wealth, a serious man with a law degree from Harvard who had made a career with a respectable white-shoe New York law firm.
But he had not completely given up on the privileges of inherited wealth.40 His estate lay on the North Shore of Long Island, now buried under suburban sprawl and, to present eyes, an unlikely setting for a secret conclave of central bankers. But in the 1920s, this was the “Gold Coast,” a Gatsby-esque world, now long gone, of mansions with gilded ceilings, of grand formal gardens and marble pavilions, of racing stables, foxhunts, and polo fields, boasting castles larger than those of Scotland and châteaus grander than along the Loire. Among those who summered there were J. P. Morgan, Otto Hermann Kahn of Kuhn Loeb, and Daniel Guggenheim, the copper king.
Its mere twenty rooms made the Mills house, a discreet and elegant neo-Georgian brick mansion with vine-covered walls, located on the Jericho Turnpike in the town of Woodbury, New York, a modest residence by the standards of some of its neighbors. A few hundred yards farther up the turnpike stood Woodlands, a thirty-two-room estate that Andrew Mellon had just bought for his daughter Ailsa as a wedding gift. Half a mile down the road stood Oheka, the second largest house in the United States, a mock chateau of 127 rooms owned by Kahn.
The four men remained in seclusion for five days, No official record of the discussions was kept. Although they socialized and had meals together, they rarely gathered as a group, relying instead upon bilateral meetings. Strong and Norman in particular spent hours “closeted together.” The discussions were almost entirely devoted to the problem of strengthening Europe’s gold reserves and to finding ways to encourage the flow of gold from the United States to Europe.
Norman dominated the proceedings, seated at one end of the conference room in a fan-backed oriental chair. In spite of the warm weather, he insisted on wearing his velvet-collared cape, which only added to the picturesque figure he evoked. He made it clear that his gold reserves were critically low. Any further erosion would force him to put up rates. The link between the pound and gold was seriously in peril. Moreover, he argued, the on-going worldwide decline in wholesale prices was a symptom of a mounting global shortage of gold as countries returning to the standard built up their reserves.41 And so it was imperative that countries with large reserves ease credit to spread the bullion around.
Rist, on the other hand, argued that the question of European gold was largely a British problem. Having made the mistake of fixing sterling at too high an exchange rate, Britain had no alternative but to continue its policy of deflation, however painful that might be.
Schacht proved to be more of an observer than a key participant. His main goal was to curb the flow of hot money into Germany, which the others saw as largely a side issue. He did warn that this was but one symptom of a wider problem—that Germany was getting too heavily into debt and that a breakdown over reparations would soon occur, with damaging consequences for the whole world. While Strong and Norman had some sympathy for Schacht’s desire to renegotiate reparations once more, they warned him to be patient, that nothing could be done till after the American, French, and British elections in 1928. Nevertheless, Strong was sufficiently concerned by Schacht’s gloomy forecast that after the meeting, he asked Seymour Parker Gilbert, the agent-general for reparations, to begin work on a new deal on reparations.