The one group who received a big shock was the small number of British people traveling abroad. Time magazine recounted how one man in an Old Etonian tie was sufficiently incensed at being offered only $3 for his pounds in New York—a “hold-up,” he called it—that he stormed off muttering, “A pound is still a pound in England. I shall carry my pounds home with me.”
The recriminations began almost immediately. Snowden in his speech to the Commons on September 20 blamed the debacle on the gold policies of the United States and France. Though Americans came in for their fair share, the greatest vituperation was reserved for the French. Margot Asquith, in a letter to Norman wishing him well on his return, captured the country’s mood when she wrote, “France will be heavily punished for her selfish short-sightedness. She has been the curse of Europe. . . .” Ironically, the one institution upon which the devaluation wrought disaster was the Banque de France. For years an urban myth insisted that it had been French selling of the pound that had set off the debacle. In fact, the Banque had hung on to every penny of its $350 million in sterling deposits. So supportive had it been during the crisis that Clément Moret was later named an honorary Knight Commander in the Order of the British Empire. The Banque de France ended up losing close to $125 million, seven times its equity capital. A normal bank would have been driven under.
Other central banks, especially those of Sweden, the Netherlands, and Belgium, that had been persuaded during the 1920s to keep part of their reserves in sterling lost enormous amounts. The Dutch central bank lost all its capital—the bitterness ran particularly deep because a few days before the devaluation, its governor, forgetting that only simpletons ask a central banker about the value of his currency and expect an honest answer, had inquired whether his deposits were safe and had been unequivocally reassured. Norman was so embarrassed by the losses sustained by his fellow central bankers that he contemplated submitting a letter of resignation to the BIS. It would have been a quaintly anachronistic gesture—like an ashamed bankrupt resigning from his club—but he was persuaded that it would be impractical for the institution to operate without a Bank of England presence at its meetings.
No ONE HAD done more to prop up Europe that summer than George Harrison. It must have seemed to him at times that he had spent most of the summer on transatlantic telephone calls—at the height of the Central European crisis he and Norman must have spoken on the phone, not a simple matter in those days, more than twenty-five times. After the first Austrian loan back in May, when few could have foreseen how far the panic would go, the Fed had provided the Reichsbank with $25 million, been ready to throw in a mammoth $500 million for the second loan that never got off the ground, supplied a further $250 million to the Bank of England, and, finally, been instrumental in orchestrating the last $200 million loan from the Morgan consortium to the British government. It had all been to no effect. Europe’s problems had proved to be much deeper, and its needs far larger, than the Fed was capable of handling.
After Britain left the gold standard, the financial crisis now spread across the Atlantic. Over the next five weeks, Europeans, fearing that the United States would be next to devalue, converted a massive $750 million of dollar holdings into gold. While some popular accounts attributed the outflow of gold to “panicky millionaires” and speculators hoping to make a buck from such a collapse, it was not private investors who were principally behind the flow but European central banks, the largest single mover of capital being the staid and upright Swiss National Bank, which transferred close to $200 million. The National Bank of Belgium moved $130 million; the already badly burned Netherlands Bank, $77 million; and the Banque de France, $100 million. Having lost its capital seven times over during the sterling devaluation out of a misplaced sense of “solidarity and politeness”—Governor Moret’s words—and having been rewarded with a campaign of public vilification in Britain, the Banque de France had learned its lesson. The cost of being a responsible global citizen was just too great.
The outflow of gold came at a particularly crucial juncture for the U.S. banking
system, then reeling under the wave of failures that had begun in the spring in Chicago. By September, the panic had swept Ohio and was circling back to Pittsburgh and Philadelphia. A committee of prominent Philadelphians, including the president of the University of Pennsylvania, the cardinal archbishop, and the mayor, published an appeal in the newspapers urging faith in local banks. To no avail—39 banks in the city with over $100 million dollars in deposits were forced to close down. In one month alone after the British departure from gold, 522 American banks went under—by the end of the year, a total of 2,294, one out of every ten in the country, with a total of $1.7 billion in deposits, would suspend operations.
The mounting bank failures intensified hoarding—$500 million dollars in cash was pulled from banks. While most of this was stashed away in traditional hiding places—socks, desks, safes, strongboxes under the bed, deposit vaults—some found its way to very unconventional spots, including, according to a congressional report, “holes in the ground, privies, linings of coats, horse collars, coal piles, hollow trees.” Anywhere but bank accounts.
The Fed had begun 1931 with a massive $4.7 billion in gold reserves. Even after the fall outflow, it had more than enough bullion and was never at any risk of being stripped bare as the Bank of England or the Reichsbank had been. Nevertheless, because of a strange technical anomaly in its governing laws, it found itself facing an artificial squeeze on its reserves.
By statute, every $100 in Federal Reserve notes had to be backed by at least $40 in gold, the remaining $60 by so-called eligible paper—that is, prime commercial bills used to finance trade. Even though the Federal Reserve banks were permitted to hold government securities, and the buying and selling of such securities—open market operations—was one of the mechanisms by which the Fed injected money into the system, government paper could not be employed as an asset to back currency. Even when first introduced in the original 1913 legislation setting up the Fed, the restriction had been redundant, since the 40 percent gold requirement was enough to prevent the central bank from being used as an instrument of inflation. By 1931, with no risk of inflation—the country in fact facing a problem of deflation—the restriction served no purpose. Nevertheless, it remained obstinately on the books.
With the Depression and the ensuing stagnation in trade, prime bills were scarce and hard to find. The Fed had to rely on gold to back its currency. Thus, in the fall of 1931, instead of having $2 billion too much gold and being grateful that some of it was finally flowing back to Europe, it found itself scrambling to hold on to its reserves. It was a manufactured problem, the result of an anachronistic regulation that had no basis in economic reality but which tied up a large amount of U.S. gold unnecessarily.
And so early that October, in the midst of the Depression, as bank runs raged across the Midwest, thousands of businesses closed down, and industrial production contracted at an annualized rate of 25 percent, the Fed raised interest rates from 1.5 percent to 3.5 percent. With prices falling by 7 percent a year, this put the effective cost of money above 10 percent. So dominant was the view that abiding by these reserve requirements trumped every other consideration, there was no internal resistance at the Fed to jacking up the cost of credit. Even the two principal expansionists, Meyer and Harrison, went along.
The president still continued to cling to the notion that private sector initiatives were the best way to revive the economy. On the evening of Sunday, October 4, he secretly slipped out of the White House and made his way to Mellon’s apartment at 1785 Massachusetts Avenue, where Harrison of the New York Fed had assembled a group of nineteen New York bankers, among them Thomas Lamont and George Whitney of J. P. Morgan & Co., Albert Wiggin of Chase National, William Potter of Guaranty Trust, and Charlie Mitchell of National City—in short, the usual suspects. Amid the Rubens and Rembrandts, which Mellon had so assiduously collected, the president outlined a plan to try to break the vicious cycle whereby people were pulling cash out of banks and banks were having to cut credit.
Banks were going under in part because the assets they held on their books could not be used as collateral to borrow from the Fed. By the fall of 1931, the neat distinction between liquidity and solvency on which the Fed, following Bagehot, had placed so much emphasis, was becoming meaningless. Many banks experiencing withdrawals would have been fine under normal circumstance, but forced to call in loans and liquidate assets in a falling market at fire-sale prices, they were being driven into insolvency. Hoover proposed that a new fund of $500 million be created by the larger and stronger private banks to lend to smaller banks on collateral that the Federal Reserve was legally unable to accept.
That meeting went on long into the evening. The bankers were dubious about the idea and kept asking why the government or the Fed did not act—had not the Fed after all been created precisely to avoid such banking panics? Hoover returned to the White House after midnight “more depressed than ever before.” The next day, prodded by Harrison, the bankers reluctantly agreed to try the plan. Over the next few weeks, the new fund lent a grand total of $100 million and then, paralyzed by its proprietors’ ultraconservatism and fear of losing money, folded. The days of the great Pierpont Morgan, when large banks assumed responsibility for propping up smaller ones and for supporting the integrity of the entire financial system, were long gone.
The bank runs, the spike in currency hoarding, and now the rising cost of money imposed a massive and sudden credit crunch upon an already fragile United States. Between September 1931 and June 1932 the total amount of bank credit in the country shrank by 20 percent, from $43 billion to $36 billion. As loans were called in, small businesses were driven into default. Lenders were forced to absorb losses and in turn lost their own cushion of capital, making depositors quite justly fearful for the security of their money and leading to further withdrawals from banks, which in turn forced more loan recalls and thus more defaults. Though depositors and bankers individually behaved quite rationally to protect themselves, collectively their actions imposed a vicious spiral of tightening credit and loan losses on the already depressed U.S. economy.
“If there is one moment in the 1930s that haunts economic historians,” writes the economist J. Bradford DeLong, “it is the spring and summer of 1931—for that is when the severe depression in Europe and North America that had started in the summer of 1929 in the United States, and in the fall of 1928 in Germany, turned into the Great Depression.” The currency and banking convulsions of 1931 changed the nature of the economic collapse. As prices fell and businesses were unable to service their debts, bankruptcies proliferated, further chilling spending and economic activity. A corrosive deflationary psychology set in. Fearing that prices would fall further, consumers and businesses cut spending, adding to the downward spiral in consumption and investment.
Every economic indicator seemed to fall off a cliff—1932 was the deepest year of depression in the United States. Between September 1931 and June 1932, production fell 25 percent; investment dived a stunning 50 percent; and prices dropped another 10 percent, reaching 75 percent of their 1929 level. Unemployment shot up beyond ten million—more than 20 percent of the workforce was now without jobs.
American corporations, which had made almost $10 billion in profits in 1929, collectively lost $3 billion in 1932. On July 8, 1932, the Dow, which had stood at 381 on September, 3, 1929, and was trading around 150 before the European currency crisis, hit a low of 41, a drop of almost 90 percent over the two and a half years since the bubble first broke. General Motors, which had traded at $72 a share in September 1929, was now a little above $7. And RCA, which had peaked at $101 in 1929, hit a low of $2. When, in August 1932, a reporter for the Saturday Evening Post asked John Maynard Keynes if there had ever been anything like this before, he replied, “Yes. It was called the Dark Ages, and it lasted four hundred years.”
In 1932, Meyer, having uncharacteristically allowed himself to be hamstrung by the Fed bureaucracy for his first year in office, finally took charge. In January, he persuaded the administration that its attempt to have the large banks voluntarily take responsibility for supporting the system had failed. The Reconstruction Finance Corporation (RFC) was established to channel public money—a total of $1.5 billion—into the banking system. Congress would agree to the new agency only if Meyer took on the chairmanship. For six months Meyer held two full-time posts: head of the RFC and chairman of the Federal Reserve Board. Eventually the toll on him became so great that his wife, Agnes, personally lobbied the president for him to resign one of the positions.
In February 1932, he pressed Congress to pass legislation that would make government securities an eligible asset to back currency. At the stroke of a pen the gold shortage was lifted, allowing the Fed to embark on a massive program of open market operations, injecting a total of $1 billion of cash into banks. The two new measures combined—the infusion of additional capital into the banking system and the injection of reserves—allowed the Fed finally to pump money into the system on the scale required. But Meyer had left it too late. A similar measure in late 1930 or in 1931 might have changed the course of history. In 1932 it was like pushing on a string. Banks, shaken by the previous two years, instead of lending out the money used the capital so injected to build up their own reserves. Total bank credit kept shrinking at a rate of 20 percent a year.
Bankers and financiers, the heroes of the previous decade, now became the whipping boys. No one provided a better target than Andrew Mellon. In January 1932, a freshman Democratic congressman from Texas, Wright Patman, opened impeachment hearings for high crimes and misdemeanors against the man once hailed as the “greatest Secretary of the Treasury since Alexander Hamilton.” Mellon found himself accused of corruption, of granting illegal tax refunds to companies in which he had an interest, of favoring his own banks and aluminum conglomerate in Treasury decisions, and of violating laws against trading with the Soviet Union. During the ensuing investigations, it turned out that he had used Treasury tax experts to help him find ways to reduce his personal tax bill and that he had made liberal use of fictitious gifts as a tax-dodging device. Being a member of the Federal Reserve Board, he had been required to divest his holdings of bank stock, with which he had duly complie
d—except that he had transferred the stock to his brother. In February, Hoover, recognizing that Mellon had now become a liability, packed him off as ambassador to London.50 His place was taken by his undersecretary, Ogden Mills.
On March 12, 1932, the world learned that Ivar Kreuger, the Swedish match king, who had bailed out so many penniless European countries, had shot himself in his apartment on the Avenue Victor Emmanuel III in Paris. At first it was assumed that he was just another victim of the times—he had recently suffered a nervous breakdown and his physician had warned him about the constant strain of his lifestyle on his heart. Within three weeks it became apparent that his whole enterprise had been a sham. His accounts were riddled with inflated valuations and bogus assets, including $142 million of forged Italian government bonds. When the losses to investors were eventually tallied, they amounted to $400 million.
Bankers were now increasingly viewed as crooks and rogues. In early 1932, the Senate Banking and Currency Committee began hearings on the causes of the 1929 crash. Designed at first to appease a public hungry for scapegoats, the hearings achieved little until, in March 1933, a young assistant district attorney from New York City, Ferdinand Pecora, took over as chief counsel. The public was soon riveted by the tales of financial skull-duggery in high places. It learned that Albert Wiggins, president of Chase, had sold the stock of his bank short at the height of the bubble and collected $4 million in profits when it collapsed during the crash; that Charles Mitchell, old “Sunshine Charlie,” of the National City Bank had lent $2.4 million to bank officers without any collateral to help them carry their stock after the crash, only 5 percent of which was repaid; that Mitchell himself, despite earning $1 million a year, had avoided all federal income tax by selling his bank stock to members of his family at a loss and then buying it back; that J. P. Morgan had not paid a cent of income taxes in the three years from 1929 to 1931.
“If you steal $25, you’re a thief. If you steal $250,000, you’re an embezzler. If you steal $2,500,000, you’re a financier,” wrote the magazine the Nation. Few critics went as far or tapped into as strong a vein of popular discontent as Father Charles Coughlin. Pastor of the Shrine of the Little Flower in Royal Oak, Michigan, Coughlin was the originator of right-wing radio. His Sunday afternoon broadcasts delivered in a soothing and intimate voice of mellow richness captivated millions as he held forth on the “banksters,” as he called them, who had led the country into the Depression.
He actually did have some understanding of the driving forces in international finance. For example, in a broadcast delivered on February 26, 1933, he explained somewhat cogently that “the so-called depression, with its bank failures, is traceable to the inordinate, impossible debts payable in gold—debts which came into being and were multiplied as a result of the war.” But he embellished his radio sermon with one of his fire-and-brimstone rants on “the filthy gold standard which from time immemorial has been the breeder of hate, the fashioner of swords, and the destroyer of mankind,” and ended by urging his listeners to rise up “against the Morgans, the Kuhn-Loebs, the Rothschilds, the Dillon-Reeds, the Federal Reserve banksters, the Mitchells and the rest of that undeserving group who without either the blood of patriotism or of Christianity flowing in their veins have shackled the lives of men and of nations with the ponderous links of their golden chain.”
The 1932 presidential campaign was dominated by the Depression. The Democratic candidate, Franklin Roosevelt, the handsome and attractive, astoundingly self-confident governor of New York, was initially dismissed as a lightweight. But his jaunty optimism—his campaign’s signature tune became “Happy Days Are Here Again”—his inspirational speeches, and his promise of vigorous action to restore prosperity made a sharp contrast with the dour and resentful Hoover.
On economics, Roosevelt had a breezy and disconcerting ability to put forward contradictory policies without the slightest embarassment. So while he pledged to increase federal relief for unemployment, supported higher tariffs, government development of power projects, increased regulation of securities markets, and the separation of commercial and investment banking, he also criticized Hoover for fiscal extravagance, accused him of encouraging inflation, and promised to balance the budget and commit himself to “sound money.” But voters did not care about consistency, they wanted bold action. In November 1932, Roosevelt got 22.8 million votes against Hoover’s 15.7 million, the greatest electoral sweep since Lincoln beat McClellan in 1864.
In the interregnum between the election and inauguration, a new wave of bank failures swept the country—this time starting in the West. On November 1, the governor of Nevada declared a twelve-day bank holiday, after the suspension of a bank chain that accounted for 65 percent of the state’s deposits. He was followed by his counterparts in Iowa in January 1933 and Louisiana in early February.