The Dark Side Part IV Chapter III - Fritz the Cat

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Dark Side 4 Chapter 3

The position of Britain was somewhat unique.  Some degree of devaluation would have made sense, as her manufacture was having trouble competing on the world stage, and her liquidation of a great part of her foreign holdings to finance the war left that financial cushion much reduced.  But the city of London was literally, the Banker to the world, taking deposits in one part of the world and lending in another.  Most trading nations kept a part of its cash reserves in sterling deposits in London.  Devaluation of the pound would have rocked the financial world.

(page 160)  Britain had also gone off the gold standard during its war with revolutionary Francis Napoleon.  It then too deflated its currency to regain the pre-war parity between paper currency and gold.  Between 1815 and 1821, it had the supply of paper money and Britain driving down prices by 50%.  The effect of this reduction in paper money fell hardest on those who had no savings, the poor, and those who had to borrow money at high interest rates, the middle class.  The year between 1815 and 1821, were years of riots and agricultural distress in Britain.

England again chose the path of deflation, raiding interest rates to 7%, and balancing its budget.  The economy was plunged into a sharp recession and two million men were thrown out of work.  By the end of 1922 prices were down by 50% and the pound was within 10% of its pre-war value.  But Britain’s less dynamic economy and internal debt prevented a rapid recovery as in the U.S.  The number of unemployed would not drop below a million for 20 years.  Industries such as cotton, coal and shipbuilding, in which she had once led the world, failed to modernize and markets were lost to the competition.  Labor cost had risen as unions negotiated shorter working hours.

Before the war, the world’s four largest economies had operated with $5 billion in gold between them.  By 1923, monetary gold had increased to only $6 billion.  Prices in the U.S. and the U.K., even after the post-war deflation, were still 50% higher than before the war, which next to real purchasing power of the gold reserves had decreased by 25%.  The real problem was the concentration of gold in the U.S.

In 1922, Montagu Norman, leader of Britain’s central bank, working with officials of the British treasury, tried to convince the European central banks to hold British pound sterling instead of gold as their reserve asset, as did many of the British Empire countries.  The plan was the result of the severe gold shortage in Europe.  Before the war, the U.S. held about $2 billion in gold, half of the four great economic country’s gold supply.  By 1923 the supply of gold had risen to $6 billion, but the U.S held $4.5 billion of it.  The U.S. had more gold than it needed to keep its economy running smoothly, and Europe didn’t have enough. Thus Norman’s plan, which however failed to catch on.  Gold could be found all over the world, but the pound was only printed in Britain.  The other central bankers could see that going to Britain to increase your reserve assets in a time of need would make them much more vulnerable vis a vis Britain.

(page 166) John Maynard Keynes was one who could see the wisdom in Norman’s plan.  He had been a staunch backer of the gold standard up until the middle of the war.  The gold standard had worked until the late 19 th century only because new mining discoveries had kept pace with economic growth.  Keynes argued that people’s attitudes toward paper money had evolved sufficiently so that the gold standard could be relinquished as a "barbarous relic" of history.  In December of 1923 he published a short monograph entitled "A Tract On Monetary Reform".  Much more technical and tentative in its conclusions, it was not the bestseller that "The Economic Consequences" was.  At a time when so many central European currencies had collapsed, few people wanted to trust politicians.  The main duty of a central bank is to keep prices stable.  In the "Tract", Keynes showed that inflation was more than just prices going up, it was also a method of transferring wealth between social groups - from savers, creditors and wage earners, to the government, debtors, and businessmen.

(page 170)   Montagu Norman and Benjamin Strong, head of the N.Y. Federal Reserve Bank, both regarded Keynes as a perhaps talented upstart, but devoid of practical experience.  Ironically, Strong’s policies in the U.S. followed Keynes recommendations - that the link between gold balances and the creation of credit be severed, that the automatic mechanism of the gold standard be replaced by a system of managed money, and that credit policy be geared toward domestic price stability.

But now, a word from our sponsor… Fritz the Cat will attempt to illustrate some of the more abstract ideas being presented with some economic history.

There seems to have been four broad stages or epochs in modern economic history: the physiocrats, who believed that all creation of wealth derived from the land; the mercantilists, who believed that money could best be created through international trade; the industrialists, who believed that the manufacturing of salable objects on the largest possible scale was the best way to make money; and finance capitalists, who believed loaning money at interest was the best way to make money.

These epochs replace each other only gradually, as was presented in my New Money Old Money thesis back in The Dark Side One.  Representative democracy was presented there as the political system for excellence for moving between the various stages without bloodshed.

The physiocrats evolved from the feudal era and distinguished themselves from the feudal lords primarily through the theories that they wrote to justify their economic procedures. We could perhaps date the beginning of this changeover roughly with the signing of the Magna Carta, the great charter that King John of England was forced by the English barons to grant at Runnymede, June 15, 1215,  Traditionally interpreted as granted certain political and civil liberties, and a milestone in the democratization of British society.  Perhaps the end of the physiocrats, at least in Britain, could be dated with the repeal of the British corn laws in 1846.

Recall that feudalism grew out of its so-called dark ages of Europe, dark in the sense that its history was not written due to the periodic invasion of the pagan   Germans whose arunic writing system was rudimentary and whose literacy virtually nonexistent. The Roman Catholic montestaries were points of light during the dark ages and kept learning alive in the Latin language. The feudal lords dominated their serfs in semi-slavery by protecting them from the depredations of the neighboring feudal lords. Some serfs escaped to the incipient cities and joined a guild (incipient trade union) to protect them economically from the burgers (incipient bourgeoisie).  The feudal states lived off what they produced while the cities traded amongst each other.  The feudal era was the rule of the strong, with the strongest as king.  The rule of the strong was replaced by the rule of the organized; first the organized minor feudal lords forced the king to give them their rights in writing, the aforementioned Magna Carta.  Then the organized bourgeoisie forced the organized feudal lords (who organized themselves by giving themselves titles of nobility) to grant them an elected parliament (1600 – 1650), and eventually put the king under the control of the parliament in the "Glorious Revolution" of 1688.

It was through these parliaments that the ruling classes were able to adjust the economic returns rewarded to the various societal actors through the enactment of laws rather than by brute strength, i.e. pillaging your neighbors.  The working classes increased their share of the pie through industrial and trade unions that bargained with the burgers rather than striking or sabotage.  Gradually the rule of law that had been developed under the Roman empire but lost during the dark ages began reasserting and perfecting itself.

As an example of this working out of relative rewards could be the aforementioned corn laws.  The feudal lords had evolved into the landed gentry  in England, and now made their money by agriculture and renting their land out.  Their elected representatives found it persuasive when arguing in parliament to expound the doctrine of "physiocracy", which held that all wealth came from the land.  Opposed to them were the "mercantilists", who argued that trade was really responsible for the creation of wealth. While the physiocrats held power in parliament laws were passed to prevent the import of corn by placing heavy tariffs on it.  When the mercantilists shipping interest gained power in parliament they were able to repeal their "corn" laws and open Britain to free trade.  Since it was cheaper to import foreign corn than grow it locally, the parliamentarians representing the new industrial interests combined with the mercantilists because cheaper corn meant the basic minimum the industrial wage-earner needed to survive was reduced, allowing the industrial owner to pay less wages and thus increase his share of the profits.

Which perhaps doesn’t lead to an unequivocal answer to the question I had – "why did inflation help German industrialists (page 122) hurt the British aristocracy?" (page 137)  Perhaps inflation serves the same function as the business cycle _ driving the less profitable out of business thus freeing up capital for the more profitable.  

But back to our book…

(page 179)   On November 5, 1923, the price of a two-kilo loaf of bread had jumped from 20 billion marks to 140 billion marks, setting off riots across the country.  In Berlin, a kind of madness gripped the city, as those with money tried desperately to spend it while it still held value, and those without money tried even more desperately to sell what they had to meet daily expenses.  There was 100,000 prostitutes of both sexes parading on the sidewalks.  The bars and nightclubs were packed.  Forty percent of the children were malnourished.  Six governments had fallen in five years.

Gustov Stressmann had become chancellor just three months earlier.  He had ended the Ruhr passive resistance campaign, which was costing $10 million a day, and persuaded the Reichstag to give him power to rule by decree.  Taxes paid for only 10% of government expenditures.  Bolsheviks controlled sections of the country, the right wing the other sections.  On the night of November 8 th, one of the right wing groups, led by Adolf Hitler, seized a Munich beer hall and threatened to march on Berlin.  The attempted coup failed within 24 hours, but some army units were thought ready to join him.

On November 12, Germany’s finance minister, Hans Luther, offered Hjalmar Schacht, one of Berlin’s most prominent bankers, director and board member of the Danatbank, the third largest in Germany, the post of currency commissioner.  He accepted and got cabinet rank, invitation to all cabinet meetings, and veto power over all currency measures.  Afoot was a plan for a new currency, the Rentenmark, to be backed by a "mortgage" on all agricultural and industrial property, which would pay a 5% tax into a new fund to support the Rentenmark.  Key to the plan’s success was a fixed limit of 2.4 billion Rentenmarks, equivalent to $600 million.

The president of the Reichsbank, Randolf Havenstein, was humiliated but refused to resign his position.  A July, 1922 law, passed at the insistence of the British, had given him life tenure with post.  Chacellor Stressmann was forced to go around him, and now there were two central banks and two official currencies in circulation.  The government no longer accepted Reichmarks, but trillions a day were printed for the use of private businesses.

On November 20, the Reichsmark traded at 4.2 trillion to the dollar and Schacht set the exchange rate at one trillion Reichsmarks to the Rentenmark, re-establishing the pre-war rate of 4.2 marks to the dollar.  Germany bought up all its back debt for about $45 million.  The old and new marks both continued to fall.  On November 26, the Reichsmark traded at 11 trillion to the dollar.  That was the bottom.  On December 10 th it was back to 4.2 trillion to the dollar where it stabilized.

(page 190)   As prices began to hold and then fall, the mad endeavor to spend money reversed itself.  It now became profitable to hold money.  Farmers once again brought their crops to market and the political climate began to calm.  Along with currency stabilization, Stressmann’s government had suspended all subsidiary payments to the Ruhr workers, fired a quarter of the government workforce, and indexed all taxes to inflation.  By January 1924, the government budget was balanced, but Schacht got the credit.

On December 20, 1923, Schacht got the presidency of the Reichsbank, Von Haverstein having died of a heart attack on November 20 th at the age of 66.  Schacht knew that monetary stability was sustainable only while Germany could stall paying reparations.  He also knew that the Rentenmark had to replaced by a currency backed by gold.  Germany had only $100 million in gold, nowhere near enough.

(page 196)   The first foreign trip Schacht made was to London on New Year’s eve 1923, to meet with Montagu Norman.  For several days they made the rounds of the financial district meeting the bankers who would be influential in bringing the German economy back to life.  

(page 200)   Meanwhile a group of Americans were steaming across the Atlantic to consider how America might contribute to European recovery.  They were bankers, not politicians or diplomats, and were paying their own expenses given the isolationism that still gripped the U.S.  They were led by Charles Gates Dawes, a Chicago banker, former Brigadier General in the American Expeditionary Force, and budget directing in the Harding administration. His fellow expert was Owen Young, who by the age of 40 had become president and chairman of the General Electric Company (tenth largest company in America), and now also president of the Radio Corporation of America.  They were met in Europe by James Logan, close friend of the New York Reserve, president Benjamin Strong.  Logan had been a presence in France since 1914, and was considered America’s unofficial ambassador to Europe.  This group became known as the Dawes Committee.

(page 205)   On January 19, Schacht was invited to speak before the Dawes group (Schacht says "summoned"), and over the course of several days was quizzed closed on the state of the German economy.  His command of details, plans for the new economy, and ability to answer fluently in the language he was addressed in impressed the group.  On January 31, the group travelled by special train to Berlin.

On April 9, the committee issued its plan.  It was vague on the touch point of total reparations.  It proposed that Germany pay $250 million in the first year and gradually increase payment to $600 million a year by the end of the decade.  The most unique part of the plan was its means of avoiding the undermining of the mark as had the reparation plan of 1922-23.  The reparations were to be raised in German marks and deposited in an escrow account in the Reichsbank.  An agent general (Dawes recommended that it be an American), a sort of economic viceroy, would decide if the money could be paid out without destabilizing the mark.  If not, the agent-general could use the money to purchase German goods, or even to provide credit to local businesses.  A second feature of the Dawes plan was that a loan of $200 million be raised abroad to help with the first years payment, recapitalize the Reichsbank, and build up enough gold reserve to jump start the local economy.  The Reichsbank was to be governed by a 14 member board, seven foreigners and seven Germans, one of whom was Schacht.

(page 212)   Taking the lead for America on the crucial loan was Thomas Lamont, by 1924 the most senior partner of J.P. Morgan and Co., after Jack Morgan.  The House of Morgan had come out of the war immensely strengthened.  London was the "banker to the world", but the war had seriously depleted its resources.  It would have to partner with America for the new loan.  Recognizing the power the bankers held, Montegu Norman insisted that the French must remove themselves from the Ruhr, and that power to declare Germany in default must pass from the French dominated Reparations Committee to an independent agency run by an American.

The European politicians were outraged that American bankers would interfere in international politics but the bankers insisted that these provisions were security on a loan, nothing more.  Eventually, Lamont made it clear that the House of Morgan might find it difficult to roll over the loan it had made France earlier in the year unless France became more reasonable. France became more reasonable.

(page 214)   On August 5 th, the heads of government met to finalize the plans.  It was the first direct meeting between the German and French heads of state since the Franco-Prussian war in 1870.  By August 14 th, the terms were finalized and submitted to Germany, with instructions to accept or reject them by morning.  By dawn everyone in the German delegation was ready to accept, except Schacht, who said, "we cannot accept them because we cannot fulfill them."  But the last word was Chancellor Stressmann’s – "We must get the French out of the Ruhr – we must free the Rhineland."

(page 215)   In September, the loan was floated in New York and London.  It started a boom in American lending to Germany that fueled a recovery in the economy and stability with currency for the next few years.  But the new economy depended on what Keynes described as "a great circular flow of paper" across the Atlantic: "The U.S. lends money to Germany, Germany transfers the equivalent to the Allies, the Allies pay it back to the U.S. government."

There were seemingly two Britains in 1924.  London was booming, and the smart international set danced the night away.  In Britain’s industrial heartland over a million and a quarter men were unemployed and another million on part-time work.  While the rest of Europe had inflated their debt away or devalued their currency, the British had chosen deflation, the gradual removal of money from the system that forced prices lower, but fell hardest on the poor and the workers.  When a given amount of gold would buy as much as it did in 1914, then and only then, would the financiers of the city of London say that no one lost by investing in England.  With prices constantly falling, no one wanted to invest money in modernizing the cotton mills, the coal mines, the shipyards, or other industries that had made Britain’s rich.  Their prices were undercut by the countries that had devalued their currency.

(page 221)   In November of 1924, a conservative electoral landslide, fueled by a fraudulent letter linking the labor party to the Soviet Union, put Stanley Baldwin in as Prime Minister, who then appointed Winston Churchill to the Chancellor of the exchequer, the second most powerful position in government.  Monegu Norman was fearful lest Britain’s economic policies fall into the hands of traders and manufactures who always liked to see a little inflation to push the economy forward.

(page 224)   Britain was trying desperately to get back on the gold standard, and the election of Conservatives helped push the pound sterling a bit higher.  But it had been stuck at $4.35 to the pound for some time, some 15% below the pre-war rate of $4.86.  At the end of  December, 1924, Norman went to New York to consult with Strong.  New York was in the middle of the "roaring 20’s" boom.  The number of cars in New York had doubled since Norman was last here, two years earlier.  There were more cars in New York City than all of Germany.  In addition, new devices like the washing machine, telephones, vacuum cleaners, new material like rayon and cellophane, and new entertainment like radio and talking movies.  At the time, the typical American worker earned $6 per day, while the typical European earned only $2 per day.

(page 225)   Official U.S. isolationism had kept Strong’s, and other bankers, at a distance from European affairs, so in the next few weeks he paraded Norman around the New York banks where each and every one, especially the Morgan bankers, impressed on him the desirability of Britain’s return to the gold standard at the earliest opportunity.  If Britain led, other countries would follow, and until the world was back on the gold standard, governments would be tempted to inflate their currencies or experiment in ideas or expedients other than gold, sure to result in another monetary crisis.

(page 227(   Strong emphasized  that a window was open that surely would soon close,  American capital was optimistic about Europe in the wake of the Dawes Plan, and the Fed had to stave off a mild domestic recession, lowered interest rates in the summer.  Both these factors would help attract American capital to Britain in support of the pound, but might end in as soon as a few months.  Strong knew that the pound was still 10% too weak, and that the deflation necessary to strengthen it would cause pain in Britain.  He encouraged Norman by offering Britain a $200 million loan from the  New York Federal Reserve Bank and the House of Morgan offered a further $300 million loan, both available only while Norman was governor of the British central bank.

(page 229)   Norman found some of the British peers resentful at American pushiness.  A premature British re-entry into a gold standard could, because of the U.S’s huge gold stockpile, end up tying Britain not to gold, but to the U.S. dollar and bind Britain to the U.S. economic trends and policies.  Worse, minor problems in the U.S economy would result in major problems for Britain’s smaller, less dynamic economy.  Even U.S. bankers worried that a premature British re-entry, if it could not hold, would damage not only faith in its gold standard, but faith in the modern economic system as a whole.

(page 232)   At this point, Churchill, chancellor of the exchecker, and by his own admission not fully conversant with the more corners of high finance, chose to educate himself by writing a memorandum on the return to the gold standard.  America, he wrote, is sitting on 3/4 of the world’s public gold, most of it unused and wishes to find employ for this gold by selling it to other nations.  A return to gold would obviously benefit the City of London’s bankers.  It is not obvious that it would benefit England’s manufacturers, merchant workers and consumers.  It could almost have been written by John Maynard Keynes.  Britain could have the best credit in the world, and still have 1.25 million men unemployed.  The sides remained divided, one side insisting that the government could be trusted with discressionary power to manage the economy, the other side insisting that politicians were fallible and needed to be restrained by the strict rules.

Most of the industrial world was already either back on gold or about ready to go back.  Churchill decided to return to gold, perhaps decisive was the implied admission of a diminished Britain had he not.  Either the world would do business in the pound sterling, or it would do business in dollars.

(page 237)  Keynes attacked sharply. The pound sterling was over-valued in the world market by 10%.  Only unemployment, with its associated cuts in wages and prices, bought in by a policy of tight credit and high interest rates, could cure that.  "The proper object of dear money is to check an incipient boom.  Woe unto them whose faith leads them to use it to aggravate a depression."  By the late summer of 1925, the rise in the exchange rate began hurting Britain’s staple export industries of coal, steel and shipbuilding.  The resumption of coal production in the Ruhr was an additional squeeze on coal.  The coal owners demanded wage cuts and increased hours, and only a massive $100 million subsidy prevented a national strike.  In May of 1926, the country did enter into a ten day general strike.  Only Britain’s continuing high interest rates and increasing turmoil in France prevented a massive exodus of capital.

(page 239)   Britain’s return to gold turned out to be a costly error.  The speculative money attracted by the high interest rates could only be retained by interest rates significantly above the market.  The over-valued pound hobbled British exports while the rest of  the world enjoyed a boom.  By 1927, Churchill realized his error and blamed Norman.

(page 241)   In March of 1924, the French government was finding it difficult to attract buyers for its short term debt, and asked the Banque de France for a loan to cover its maturing bonds.  But the government was already up against the debt limit set by parliament and the political climate was not right for asking for an increase.  The Banque de France and the Ministry of Finance together cooked the books until by April, 1929, these "fake balances" amounted to 5% of the money in circulation.  Then word leaked out and the government of Prime Minister, Edward Harriet, fell to a vote of no confidence.

(page 246)   The Banque de France was the most conservative in Europe.  In 1914 it held $1 billion in gold reserves.  It had rescued the Bank of England in 1825, 1837, 1890 and 1907.  It was owed by its shareholders, by this time run by the higher civil servants, who were responsible to a twelve man Board of Regents, the seats, in practice, being passed down through the family lines of the great aristocratic families, disproportionately of Protestant Swiss extractions.  In its 120 year existence, it had passed through three revolutions, five different political systems, one Emperor, three kings, twelve presidents, and a president who made himself Emperor.  Governments had changed at least once a year.  It had continued unmolested through the Paris commune, loaning money to both sides. It was limited to 200 shareholders, giving rise to the 1930’s myth of the two hundred families who ruled France.  

(page 247)   Like all other European banks, the Banque de France had thrown caution to the wind during the first World War, and printed money on demand for the central government.  After the war, in April 1919, the National Assembly fixed a limit on the national debt, and in September, 1920 placed a 41 billion Franc limit on the notes in circulation.

(page 249)   The French Franc was the only major currency still off of the gold standard.  In the spring of 1924, during the Dawes negotiation, it had hit bottom at 25 to the dollar.  It had recovered to 18-19 to the dollar for the year before the "cooked books" scandal hit the news, when it fell to 22 to the dollar.  The new premier, Paul Painleve, found a left-wing coalition and hired Joseph Cailloux, veteran of four previous tours as finance minister, with a brilliant reputation but a stormy political history.  He managed to get Churchill to write down France’s debt to England, but had no such luck with the U.S.  Likewise, the French middle-class that held the short-term bonds that needed to be rolled over every year, were not in a generous mood.  In Cailloux’s seven months in office, the cost of living had risen by 10%.  When he was fired, the Franc touched 25 to the dollar.  In the next eight months, France had five different finance ministers.  Confidence continued to collapse and French investors continued to pull their money out of the country.

In April, 1926, France negotiated its debt to $0.40 on the dollar.  The budget was balanced yet the franc continued to fall.  By May it was 30 to the dollar.  Inflation hit 25% a year.  People began to recall the Germany of four years earlier, but unlike Germany, France had solved its fiscal problems and its money supply was under control.  

(page 251)   In fact, the deep divide between the left and right had made the country ungovernable; its ability to raise enough taxes to fund the government latched onto by speculators who bought the franc, betting that it would fall further, not an unreasonable assumption given the France’s short-term debt overhang.  In early 1926, the government tried to persuade Banque de France to use its $1 billion in gold as collateral of raise foreign funds to support the franc.  It would not, later giving rise to accusations that the French plutocrats had always been determined to oust the left-wing government.  The U.S. Federal Reserve and every major investment bank refused loans until France got its political house in order.  

(page 254)   On June 15 th, Cailloux was again posted to the finance ministry.  By June 24 th, he had fired most of the top management of the Banque de France and hired his old friend Caime Moreau as governor.  The franc was at 35 to the dollar.  On July 17 th, another left-wing government collapsed, having lasted four weeks.  It was followed by another left-wing coalition that lasted 72 hours.  In the streets there was talk of revolution or a coup de tat.

In the early 20’s, with the franc at one quarter its per-war level, France became a magnet for American tourists.  Boat passage could be had for $80, and by 1926, and estimated 45,000 Americans lived in Paris, and another 200,000 came during the summer.  The French were not amused, as the American’s bought up choice properties.  The U.S. ambassador bought the U.S. a new embassy out of his own pocket on the day the franc hit 27 on the dollar.  Built for the equivalent of $1 million in the late 19 th century, Ambassador Herrick paid $200,000 dollars for it.

(page 261)   On July 21 st, the conservative Raymond Poincare, was asked to form a ministry.  On the day he became the Prime Minister, the franc hit 50 to the dollar, but in ten days had recovered 40% to 35.  Expatriated French money began returning, and by the fall threatened trouble from the other end of monetary spectrum, an over-valued franc that stifled exporting, and since a stronger franc would buy more goods, the price of goods, in effect, was falling.  Since no one wanted to buy something that would be cheaper in the future, this resulted in business stagnation, as had happened in Britain when she re-entered the gold standard with an over-valued pound sterling.  It also aggravated class relations because the rich were often being repaid in francs that were worth more than the ones they had loaned by taxpayers in a stagnant economy.  As Chancellor of the Banque de France pointed out, "fixing the exchange rate was a matter of balancing the sacrifices demanded of the different social classes in the population."

(page 264)   Every country in Europe to emerge from the war faced the same set of issues. Britain had chosen one extreme: to impose most of its burden on its taxpayers and to protect its savers.  Germany had chosen the opposite extreme: the way of pathological inflation, which had wiped away its internal debts at the price of annihilating the savings of its middle-classes.  Moreaur was set on finding a middle way.

(page 267)   On December 21 st, the bank began to purchase foreign exchange and sell its own currency to keep the franc from rising above 25 to the dollar.  Speculators continued to attack the franc, but by the middle of 1927 it was clear that Moreau had won, and French money continued to return home from London and New York at 25 francs to the dollar.  French exports were among the most competitive in the world as exports boomed, and prices were stable.  But at that rate, the franc was undervalued, which would eventually undermine the world economic system.

(page 271)   The Fed, under Benjamin Strong, kept the U.S. economy stable from 1922 on.  Zero inflation led to low interest rates, and the new industries of automobile and radio led the economy forward.  Factory mechanization allowed productivity to rise sharply, while wages grew only moderately, fueling an increase in the rate of profit.  Much of this profit was attached to the stock market, and the land speculation boom is south Florida.

(page 280)   By the beginning of 1927, Germany seemed to have recovered from its bout of hyper-inflation.  Schacht had consolidated his position in the Reichsbank, and his frequent meetings with Strong and Norman signaled his acceptance as a member of the central bankers who ran the world’s finances.  In the three years since the mark had been stabilized, output had risen by 50% and exports by 75%; unemployment was at 6% and prices were steady.  By 1927, the stock market had quadrupled in value over its 1922 bottom.

(page 283)   Under the Dowes plan American bankers were assured repayment ahead of British and French reparations and in the plans two year existence, $1.5 billion in loans flowed into the country, much of it wasted on frivolous projects that could never generate the foreign currency that would be needed to repay the loans.  Loans were available to communities and swimming pools, and opera houses began popping up in small towns, undermining Schacht’s argument that Germany could not afford reparations.  

(page 284)   Some foreign observers thought Schacht began purposely undermining the recovery to belittle their argument.  On May 12, 1927, the Reichsbank instructed every bank in Germany to cut its loans for stock trading by 25% immediately.  The Berlin stock market fell by 10% that day and another 20% over the next six months.  The move was ineffectual, The stock market was still undervalued, being capitalized at only 60% of its pre-war value, and it had no effect on the borrowing of municipalities.  It did, however, damage business confidence.

(page 285)   Berlin was rife with rumors Schacht was trying to engineer a crisis to undermine the Dawes plan.  His behavior became irresponsible and unpredictable.  Norman and Strong began to fear that some foolhardy gamble by Schacht would plunge the world into a new monetary crisis.  He began blatantly interfering in politics and criticizing the government, revealing confidential details of cabinet debates and insulting individual politicians.

(page 286)   In France, the return of French gold that had begun with the election of conservative Poincare, began to undermine the competition of the franc and the Banque de France was buying huge amounts of foreign currency to stem the competitiveness of the franc’s rise.  By May 1927, it held $700 million of foreign currency, half of it sterling.  With the return of the gold came a return of French assertiveness.  Moreau and Norman had long distrusted each other, and Moreau resented Norman’s lack of help during France’s financial travails, especially given the help Norman had given Germany.

(page 287)   With the franc stable and flush with hard currency, Moreau was determined re-establish France’s financial prestige.  Before the war, Paris had been the world’s second most important financial center.  In 1926, a consortium of central banks, including the Federal Reserve, the Bank of England and the Reichsbank, and the Banque de France, put together a financial package to stabilize the Polish zloty.  When Norman’s Bank of England tried to grab the lead role, Moreau objected strongly to the British attempt to muscle in on France’s traditional sphere of influence in Eastern Europe.

In February 1927, France attempted to renegotiate a 1916 loan from England, but Norman put obstacles in the way.  In May, France announced that it would pay off the Britain loan and take back the $90 million in gold reserves pledged as security.  The next month, without consulting England,  the Banque de France issued instructions to convert $100 million of it’s sterling balance into gold, which would drain almost $200 million in gold out of the Bank of England’s reserve.

(page 288)   The gold standard contained a mechanism for readjustment after these shifts in gold holdings.  When a country lost gold reserves, it was supposed to lead to an automatic contraction in credit and a rise in interest rates, thereby shrinking it’s buying power and attracting money from abroad.  The opposite would happen with the country gaining gold: it’s credit expanded and it’s purchasing power increased.  The "rules of the game", as Keynes called them, were intended to balance the world’s money supply.

But now a word from our sponsor:

The effect of gold on the amount of credit on a country needs to be clarified perhaps. I believe that these "rules of the game" were gentlemen’s rules in this time period, and were more or less codified at Bretton Woods after WWII.  Money in the modern world is divided into two major categories – currency and bank deposits, with people tending to hold more money as currency in periods of perceived monetary or political uncertainty and vice versa.

Modern banks adhere to a "fractional reserve" system, whereby banks hold a percentage of their deposits as cash reserves in the vaults of their banks to allow customers to hold their money as currency rather than deposits, i.e., to withdraw money from a bank, the Federal Deposit Insurance Corporation (F.D.I.C.) requires member banks to hold a certain minimum fraction (currently 9%?) of its deposits as currency in its vaults.  A part of the money held on reserve can be loaned out, allowing for the private sector to participate in the creation of money.  Government’s banks expand or contract the private creation of money by lowering or raising the interest rate they charge banks for money.

Gold held as a part of reserves also constitute part of the money which may be loaned out, to so-called "high-powered" money.  When the U.S. held gold reserves far in excess of its needs to back up its currency, as happened after WWI in the U.S., Benjamin Strong, head of the New York Federal Reserve Bank feared that the excess would be used as collateral for loans which would enlarge the money supply beyond the amount needed for commerce, setting the stage for inflation.
When Moreau used the foreign exchange acquired from the boom in exports while the franc was undervalued to pay off the British loan and regain control of the gold pledged as security, and later exchanged the pounds sterling held for gold, it would seem as he was perhaps trying to drive Britain off the gold standard.  When Norman pointed out that France still owed Britain $3 billion in war debt which theoretically could be called in at any time, Moreau backed off.

When France took gold out of Britain’s pile and put it in hers, the effect was, by the "rules of the game" they were playing, harmful to both sides.  By losing control of some of the gold it used as collateral for the loans it had extended, Britain had to raise its interest rate, attracting foreign money to back up it’s banking system and to discourage business expansion domestically.  Since Britain was already deflating its currency to absorb the inflated money it had used to pay for WWI, which fell hardest on the working class as we saw earlier, the additional deflation caused by the contraction in credit worried Norman and Strong about possible riots by workers pushed out of jobs.  On France’s side, the additional gold reserves could make the franc stronger, threatening its export boom and add to the temptation to create more money and fuel the inflation it was so anxious to avoid.  After a series of meetings, both sides backed down.  The Bank of England would raise its rates modestly and the Banque de France lowered its rate.  So back to our book.

(page 292)   In May 1927, the quarrel between Norman and Moreau was threatening to derail the pound and undermine the stability of the world-wide gold standard.  Schacht was pushing for an international initiative to control the flow of foreign loans into Germany, fearful that the accumulated debts would drown her.  Strong was still hoping that with the world back in the gold standard, the U.S.’s lopsided accumulation of gold would correct itself.  The pound remained overvalued and refused to fall, and the franc remained undervalued and the Banque de France would not let it rise.

One thing the U.S. could do would be to lower its interest rate.  That would make her loans to Germany cheaper and help direct money to Britain and France.  It would be good policy domestically as well, as the U.S. was in a mild recession and prices around the world were falling; since 1925 U.S. wholesale prices had fallen 10% and consumer prices by 2%.  

(page 294)  But the interest rate was already a low 4%, and a faction within the Fed thought Strong too influenced by considerations of Europe.  That same faction thought Wall Street headed for a bubble, which lower interest rates would exacerbate.  Loosening the monetary policy now to aid Europe risked a severe split in the Fed.  Yet even worse, would be a Britain, whose gold reserves were precariously low, forced off the gold standard.

(page 297)   Britain argued that the world wide decline in wholesale prices was a symptom of the mounting shortage of gold as countries returning to the gold standard built up their reserves.  For most goods, when demand exceeds supply, the price of gold rises.  With gold prices fixed, the first symptom of a gold shortage was not a rise in its price – which by definition could not happen – but a fall on the price of all other commodities.  And so it was imperative that countries with large reserves of gold ease the credit rate to spread the gold around.

A few days after the European central banks left, the New York Federal Reserve Bank and eight other reserve banks voted to cut the interest rate to 3.5%.  Four other reserve banks voted against the move saying it would only fuel the stock market bubble, but they were forced to follow majority rule, which also split the Fed, and in the recriminations, the Chairman of the Board, Daniel Crissinger, resigned.

(page 299)   In August, following the Fed’s cut in rates, the market immediately took off.  By the end of the year, the DOW was up 20%.  The cut helped Europe, but by February 1928, Strong realized it had been a mistake.  Over the next three months, the Fed raised the rate to 5%.  In later years, Strong’s critics would claim that this rate cut had initiated the bubble that burst in 1929, leading to a world depression.  They had a strong argument.

Norman and Moreau continued their power struggle, now over who would take the lead in loans to Romania.  Romania was a former client state of France, but during France’s recent economic troubles, Britain had gained influence.  Norman felt that Strong was beginning to drift away from England and to give more attention to France’s problems.  Strong began to hear complaints from European banks that Norman was using his friendship with Strong to pressure them to adopt policies beneficial to Britain.  Both Schacht and Moreau were behaving increasingly erratically, failing to consult and inform subordinates, throwing temper tantrums, retreating into isolation.  The nervous strain was showing on all of them, forcing Norman to take repeated rest breaks, and undermining Strong’s already perilous health.  Strong died from complications of surgery treating his tuberculosis on October 15, 1928.

More editor’s comments:

"Those who sow the wind will reap the whirlwind." (Hosea 8:7)  Ahmed, the author of this book, does not make as explicit as does Shirer in his book, the collapse of the Third Republic (reviewed in the Dark Side III), that the cause of France’s economic problems during the last half of the 20’s was due to the wealthy classes of France removing their gold from France in protest against the political policies pursued by the left-wing coalition elected in 1924.  By removing their wealth (the left would say the nation’s wealth), they in effect starved the left into submission, causing its downfall and the shift of power to the right under the conservative Poincare.  

This is in effect a capitalist’s strike.   I have been arguing that since the Dark Side II, that although the depression of the 30’s perhaps was not intended to result in WWII, that was its perhaps all but inevitable effect, and that this depression we have been going through since 2008, or perhaps of 2005, is yet another capitalist strike.  The next world war, which seems to Fritz to be rapidly approaching, will be blamed on Putin just as the last one was blamed on Hitler.

Now, if we give the western power the benefit of the doubt, and allow that perhaps the capitalist strike of the late 20’s was not meant to end in WWII, it will be much more difficult to give them the same benefit of the doubt this time because they are doing the same exact thing again and can only expect WWIII to be the a result.

As was mentioned earlier, the stock exchanges of the world are driven by two emotions: fear and greed, both of which are highly contagious.  When you see your neighbor making money, you jump in.  When you see your neighbor lose his money, you jump out.  Booms are fueled by greed and panics are fueled by fear.

As explained in the Dark Side II, the powers that be, the media and the Federal Reserve Board primarily in this case, use their ability to manipulate the boom/bust cycle to further their other goals.  It would seem in the case of the previous depression-war cycle, that those goals were to establish Anglo-Saxon control of the western world’s economy.  It is the purport of the Dark Side series that we are now (fall of February 2014), in the midst of another depression-war cycle to consolidate this control.

It is possible that the seeds of the Dark Side I "New Money, Old Money" argument were planted at this point of the Lord’s of Finance book, which I first read some time back.  In that book, copywrite 2009, Ahmed uses the term "new economy – old economy", which is a better term for how capitalists make their money, as "new money – old money" has been used in the past to describe how capitalists spend their money.

We are now 3/5 of the way through the book, and roughly at the Spring of 1928.  The boom phase of the business cycle has reached its "giddy" phase, what Allen Greenspan described as "irrational exuberance".  So once again, back to the  book.

"At particular times, a great deal of stupid people have a great deal of stupid money." ~ Walter Baghot

(page 308)   From 1922 to 1927, profits in the U.S. went up 75% and the market rose with them.  The 20’s market was split into the "old economy" of textiles, coal and railroads, which on average lost money, and the "new money", of oil, electric, trucking, automobiles, radio and consumer appliances, which on average gained.  During the second half of 1927, despite a weakening in profits, the DOW rose 30%, but without the erratic moves and frentic trading that was to come.  

During the summer of 1928, the market seemed to break loose from economic reality.  During the next 15 months, the market nearly doubled, while profits maintained their steady 10% per year advance.  The amateurs had entered the market.  By 1929, the market had become a national obsession, with its headquarters in New York City, whose newspapers were filled with "get rich quick" stories.  In February of 1929, U.S. President Calvin Coolidge declared that stocks were "cheap at current prices" and conditions absolutely sound.

(page 315)   The new President, Herbert Hoover, admitted in private that the market was in a bubble, but felt there was nothing he could do about it.  The Treasure Secretary, Andrew Mellon, who sat on the Federal Reserve Board, seemed oddly detached.  Senators and Congressmen held hearings which largely showed how little they knew about how the market worked.  They presented a morality play, putting those who, like Hamilton, believed that great wealth was the reward for taking risks, and those who, like Jefferson, believed that prosperity should be a reward for hard work and thrift.

Farmers were particularly hard hit as the demand for money outstripped its supply.  Commodity prices had been falling for a decade as the U.S. deflated away its war debt and now the credit they needed to mechanize agriculture was being sucked into Wall Street’s insatiable maw

The Fed was in a difficult position.  When the Fed cut interest rates to 3.5% in July of 1927, it perhaps ignited the stock market bubble.  It raised rates to 5% between February and July of 1928, but Wall Street easily outpaced those gains.  Gold was beginning to flow in from Europe, posing the possibility that Britain would be drained of gold and forced off the gold standard.  If the Fed’s raised rates further, they risked crippling the U.S. economy.

(page 318)   With Strong’s death, the position of the head of the New York Federal Reserve Bank passed to the man he had been grooming, George Harrison. With the forceful Strong gone, the Federal Reserve Board, they tried to gain more control over the Federal Reserve System.  The Board opposed using interest rates to manage Wall Street, and proposed "direct action" against them.  The Board sent directions to its member banks not to borrow money from the Fed to make loans for speculative bets on Wall Street.  When this news was made public, Wall Street fell for a few days and then quickly recovered its losses.  The Hearst newspapers made known the business communities opinion: "If the Board thought buying and selling stocks was wrong, they should make it illegal.  If not, they should mind their own business."

(page 320)   Montague Norman came to meet Harrison to propose a plan: raise the interest rate to 7%, or higher, to break the spirit of speculation.  Harrison went to Washington to propose the plan to the Board, and the following day Norman met with the Board to repeat it.  On February 11, the New York Fed voted unanimously to raise the interest rate by 1%, but the Federal Reserve Board in Washington vetoed the raise, a pattern which would be repeated ten times over the next three months.  Meanwhile, the pace of speculation was accelerating.

(page 323)   Of particular interest to the Board were "broker’s loans"; a stock broker could loan money to someone who wanted to buy stocks from him but didn’t have enough money.  The buyer could put up as little as 10% cash, with the broker providing the rest.  Interest on these loans ran from 10% to 20%, making the Fed’s proposed raise of 1% ineffectual.  Moreover, money was coming into New York from all over the world.

At the end of March, 1929, it was announced that broker’s loans exceeded $7 billion.  The stock market fell in anticipation of Fed action, the brokers raised interest rates to over 20%, and the president of New York’s National City Bank, Charlie Mitchell, himself a director of the New York Fed, called a press conference and announced that his bank would pump and extra $25 million into brokers loans to support the stock market.

Since the Board had first declared war on broker’s loans in early 1928, until October of 1929, banks had cut their broker’s loans from $2.6 billion to $1.9 billion.  Other sources of credit – U.S. corporations, British stockbrokers, European bankers and even some Oriental pontentates, increased their funding of broker’s loans from $1.8 billion to $6.6 billion.  Even one of the Boards most vocal opponents of speculation, Adolf Miller, was found to have invested $300,000 of his own money with a New York bank, at 12%, that fed this call market.

(page 324)   In addition to feeding this soon to burst bubble, the drive for a higher return on investments threw Germany into a recession.  Recall that  Schacht had tried to wean Germany from its dependence on foreign loans.  Between 1924 and 1928 Germany borrowed some $600 million a year, of which half went to reparations and half went to internal consumption.  Of the $3 billion Germany borrowed during these five years, $2 billion was in stable long term loans and the rest in "hot money" short term loans attracted to Germany’s 7% interest rate, which could be withdrawn when it matured, typically at the end of its 90 day term.  With the New York markets broker’s loans earning 10% plus, this is just what happened.

Under the Dawes Plan, Germany was to be fully recovered by now, and was to begin reparations payments of $625 million a year in 1929.  This was 5% of its GDP, manageable in ordinary times, but with its new constitution still fragile, its body politics still divided, its people still bitter over defeat, and its middle class decimated, by the ravages of the inflation years, Germany simply could not pay this amount.

(page 326)   Nevertheless, America’s Agent General for reparations, Seymore Gilbert, 36 years old in 1929, a finance boy wonder and workaholic, called for a conference in 1929 to definitively set Germany’s war reparation debts.  He proposed that Germany be set on its own two feet, above all by eliminating an escape clause in the Dawes Plan which allowed Germany to suspend payment in a currency emergency.  By setting Germany on its own two feet, Gilbert was in effect eliminating his own job.  Perhaps he was influenced by the highly lucrative partnership J.P. Morgan had just offered him.  If it was not the ideal time for a final settlement, as some thought, perhaps it was best to get it done while the rest of the world was in an economic boom.

(page 328)   The two sides came into the conference with very different expectations.  The allies told Gilbert not to accept any plan below $500 million a year, and Schacht was telling the right wing reactionaries he was flirting with that he could get below $200 million.  The meeting was held in Paris in February 1929.  France, fueled by soaring exports, high savings and large capital inflows, was expanding at 9% a year.  In the last two years, the French stock market led the world, outpacing even Wall Street.  It had gone up 150% since 1926, while the DOW had raised 100%.

Owen Young, the G.E and R.C.A president, was chosen to chair the proceedings.  On the second day, February 10, Schacht made his opening offer of $250 million per year for the next 37 years.  Moreau told Young that France wanted $600 million a year for 62 years.  Young tied the diplomats up in sub-committees for the next six weeks while he did some back channel shuttle diplomacy between France and Germany.  Schacht’s tantrums alienated the rest of the delegates.  The French police tapped the German’s phones.

When the final decision was made, Schacht turned pale; $525 million a year for the first 37 years, and $400 million a year for the next 21 years. If Schacht left the conference a financial crisis in Germany was almost certain, and if he accepted the bill, Germany would hate him.  Schacht said he would only accept the bill if Germany’s overseas possessions were returned, including the contentious Danzig corridor given to Poland to give it access to the sea. All this was contrary to the 1919 settlement at Versailles.  

(page 334)   The reaction was immediate.  French depositors withdrew $200 million from German banks by noon the following day. In the next ten days, Germany lost $100 million in gold, forcing it to raise its interest rate to 7.5%, despite being in deep recession with two million unemployed.  Schacht threatened to default, which would set off a global financial meltdown.  German banks, municipalities and corporations owed money to everyone - $500 million to British banks, several hundred million to French banks, and some $1.5 billion to American lenders.

While Schacht was a gambler and willing to risk a financial catastrophe to get his way, the German parliament did not want to go back to its pariah status and repudiated Schacht’s maneuver, and sent him back to the negotiating table.  But Schacht would not be made a scapegoat and demanded that the cabinet take public responsibility for the final settlement.

(page 336)   The final agreement was signed in June 1929. Germany would pay $500 million a year for 36 years, and then pay $375 million a year to the U.S. to pay the allies war debts.  A new bank, the Bank of International Settlement (BIS), jointly  owned by all major central banks, would be set up to administer and where possible "commercialize" – the modern term is securitize – future payments, that is, to issue bonds against them.  Schacht supported the agreement in public, but privately he predicted that the crisis was only postponed for a few years, and would arrive with even greater severity and result in a terrible drain in the German people’s standard of living.

(page 339)   The world’s economy was a minefield that spring and summer of 1929.  Germany on the brink of default, a shortage of gold, falling commodity prices, Wall Street out of touch with reality, and a weak pound sterling held hostage by the Banque de France.  Interest rates were 20% in New York, and three of Europe’s central banks had raised their interest rates in the past three months.  In May, Germany had to take an emergency loan of $20 million to pay its public employees.

(page 341)   As the world’s gold gradually made its way to New York, governments raised interest rates to try and retain it.  With the steady erosion of commodity prices, the real price of money was over 10% in many countries.  By 1928, the world’s big commodity producers, Australia, Canada and Argentina were in recession.  They were joined by Germany and Central Europe by early 1929.

Rising corporate earnings fueled Wall Street.  Speculation took over and money left the proven earners like General Motors, and entered stocks deemed to be the next big thing, Montgomery Ward, General Electric and RCA.  On September 3, 1929, the DOW topped out.  Most of the professional traders were already out.  Owen Young had sold out in February.  David Sarnoff, Young’s vice-president at RCA and a member of the U.S. delegation to the Paris conference, got out in June.  Even the most optimistic, who promoted the virtue of long-term investment, were out by September.  

(page 344)   Throughout the summer of 1929, Britain saw its gold drain away.  By the end of July, the Bank of England had lost $100 million of its $800 million stock of gold.  In August and September, it lost $45 million more, mainly to the U.S.  France, powered by its undervalued franc, continued to accumulate gold and foreign money.  By the middle of 1929 it held $1.2 billion in gold, and $1.2 billion in foreign exchange.

(page 345)   In June, the British voted out the conservative Tories and a minority Labor government took over.  The new Chancellor of the Exchequer, Philip Snowden, was a long and bitter opponent of France and the French position on reparations.  In August of 1929, at the Paris Reparations conference, Snowden used an English phrase "ridiculous and grotesque", to describe the French position, which translated very poorly into French.  France’s finance minister, Henri Cheron, a "fat, excitable" man, challenged him to a duel, straining relations between the two countries.  At one meeting, Pierre Quesnay, of the Banque de France, was said to have threatened to convert France’s holdings of sterling into gold unless the British conceded.  In August, British holdings of gold hit a post-war low and Norman warned his fellow directors to prepare for impending havoc.

But now a break for some editor’s comments:

History is largely the record of the transfer of power from a country in decline to a country in ascent, usually accomplished through war, the ultimate arbiter of a country’s standing.  A struggle for power also goes on within countries, which was described in the Dark Side I.   The historical chain of power centers was agriculture, industry and finance.

In Dark Side III we saw how an industrialized Germany overran the still, in many ways, feudal and agricultural France.  In Dark Side IV, we are looking at the financial record of WWII, in which the financial acumen of the Anglo-Saxon world was able to triumph in a Germany that was industrialized but had to either buy or steal commodities.  

I am researching books I had read to support the hypothesis that the "new money – old money", or better, "new economy – old economy", divide was the driver of world history.  It would seem that the primary tool that finance capital has is the interest rate.  The interest rate is the price of money.  Money is a commodity used to produce other commodities.  Central banks produce money and sell it.  Cheap money leads to the production of commodities, high employment and greed.  Expensive money leads to stagnation, unemployment and fear.

High interest and low interest are used to trigger their respective emotions, greed and fear, which then run out of control until they exhaust their energies.  This is good in that without greed economies stagnate, and without fear they produce more than they can sell or even use.

We saw how the interest rate could be used as a tool in the struggle for power both within a country and between countries.  For instance, when Britain was forced after WWI to choose between a low interest rate which would stimulate industry and make the workers happy, or high interest rates which would attract money to England, which it could then loan out at a profit, which would make the rich happy.  On the international scene we saw the high interest rates available in New York drain money from around the world into New York, which then used that money to displace London as the world’s banker.  Now back to our book.

(page 351)   The U.S. had entered a recession in August of 1929, although no one was aware of it at the time.  There were signs of an economic slowdown, especially in the more interest rate sensitive sectors.  Automobile sales had peaked and construction had been down all year, but most of the short-term indicators, for example steel production or railroad car loading, remained exceptionally strong.  

(page 353)   As often happens, the stock market crash of October, 1929, started with the collapse of a single company, in this case, a British one.  On Friday, September 19, the empire of British financier, Clarence Hatry, collapsed, leaving investors with close to $70 million in losses.  Hatry had already gained and lost several fortunes.  He had acquired a major U.S. steel company, United States Limited, for $40 million in what would today be called a leveraged buyout. In June, his bankers withdrew support at the last moment.  He was Jewish, and his extravagant displays of wealth had made him personally persona non grata among the British establishment.  Having borrowed all possible on his companies, he resorted to forgery, and when rumors surfaced that he was massively overextended, his companies shares plunged, and his bankers called in their loans.  The next day, he turned himself over to the authorities.  British investors were forced to liquidate their U.S. holdings.  On Monday, October 14, the DOW opened around 350, a little less than 10% below its all time high.

(page 354)   By the third week of October, it had lost 20% of its September all time high, but there was still no panic.  On Wednesday, October 23, a wave of sell orders, their origin a mystery, knocked 20 points off the DOW in the last two hours of trading.  The next day, Black Thursday, new sell orders arrive from across the country. By noon, the major indices had fallen 20%.  Word spread and a crowd of sight-seers surrounded the stock exchange.  600 police arrived to maintain order.  New York bankers made $20 to $30 million in highly public trades to try to stem the tide, but even all of New York’s bankers couldn’t buy all of the stocks the U.S. public wanted to sell.  The New York Fed dropped interest rates half a point to 5.5%, but the Washington Board vetoed the move.
(page 356)   The Friday Wall Street Journal arrived with banner headlines announcing that the Morgan bank had organized a $1 billion support package.  Monday, October 28, Black Monday, saw another wall of sell orders.  By the end of the day, the DOW had lost 14%.

The New York City banks held their reserves in call loans to stockbrokers and the collapse of stock prices inevitably raised concerns about the safety of one or another bank, often leading to bank runs.  The Fed had been created to break this link, and George Harrison, head of the New York Fed, spent the day conferring with the city’s banker.  When someone brought a stock with a stockbroker’s loan, the stock was held as collateral.  If the stock’s price fell and the buyer could not make his "margin call" to limit the loss of the broker, the broker could sell the stock to limit his loss.  But the mass of overextended speculators failing to make margin calls forced overextended stockbrokers to sell into a falling market, creating a vicious circle.

That night, Harrison and his staff devised a plan to inject $50 million into the banking system by buying government securities.  The next day, the financial district looked like a city under siege as 10,000 spectators gathered outside the stock exchange to watch the days events.  That day, 16 million shares traded hands.  In the last six weeks it had lost 50% of its value.

(page 360)   Harrison had sold the government securities without authorization from the Washington Board (no time, he said), and the next few days were filled with lawyers bickering over jurisdiction.  They declared a truce for the duration of the crisis, with Harrison promising not to go over a $200 million limit, allowing him to draw on the whole Federal Reserve System and not just New York’s.

The call was raised to close the stock exchange, as had been done at the outbreak of the war in 1914, a suggestion Harrison strongly opposed.  Instead he proposed that the New York City banks buy a good portion of the stock broker’s loans to prevent them from being dumped onto the market.  The Federal Reserve would provide the money to maintain the bank’s legally required reserves.  Over the next few days, the banks bought over $1 billion worth of broker’s loans.
By the last week of November, the DOW had settled at 240, a 40% retreat over the last week of September.  The bubble had lasted a year and a half.  By all indications the stock market was now near its fair value.

(page 361)   Industrial production fell 5% in October and another 5% in November.  Unemployment, 3% in the summer of 1929, was up to 6% by the spring of 1930.  Car registration fell by 25% and radio sales in New York were off by 50%.  Luxury buying was off sharply, fur coats could be bought second hand at attractive prices, and it was a buyers market in servants, including butlers and chauffeurs.  The U.S. government expanded public works construction and cut taxes by 1%, but the construction only amounted to 2.5% of the GDP, and fiscal measures injected less than a half percent of the GDP into the economy.

(page 363)   President Hoover was forced into a cheerleading role which he was ill suited for.  The economy experienced spurts of growth.  In the spring of 1939, the stock market rallied by 20%, and Hoover declared the depression over.  He declared employment on the rise when it was clearly not.  The chief of the Bureau of Labor Statistics was forced into retirement when he publically disagreed with the administration’s official statement on unemployment.

(page 364)   Treasure Secretary, Andrew Mellon, one of the U.S.’s richest men, declared that speculators deserved their losses and the best policy now was to "liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate … People will work harder, live a more moral life … enterprising people will pick up the wreck of the less competent."  The Russian government, in desperate need of money, sold Mellon 20 of the Hermitage’s treasured paintings in great secrecy, for $7 million.  On one occasion in September 1930, he was so engrossed in a discussion with one of his art dealers that he kept a group of bankers waiting for two hours.

(page 365)   With the government unable or unwilling to act, the task of managing the economy fell almost entirely to the Fed.  In June of 1930, the Fed eased monetary policy dramatically.  It injected close to $500 million in cash into the banking system and cut rates from 6% to 2.5% - mostly the work of Harrison in New York.  The Federal Board in Washington accepted his moves grudgingly.  Seven of the twelve regional bank governors resisted his attempts at vigorous easing, fearing that would only set off another round of speculation.  In the early summer, the Fed stopped easing and industrial production fell 10% between June and October.

(page 369   The crash was greeted with relief in Europe.  Perhaps now gold would start flowing home, and Europe would be able to lower interest rates and restart their economy.  European stock markets fell in sympathy with Wall Street, but not having risen so high, did not fall so far.  While the U.S. market slid 40%, Britain’s went down 16%, Germany’s 14% and France’s only 11%.  As credit conditions eased in the U.S., foreign lending revived.  Central banks, no longer having to defend their gold reserves from New York, could cut interest rates.  By June, 1930, with U.S. rates at a post-war low of 2.5%, the Bank of England was down to 3.5%, the Reichsbank down to 4.5%, and the Banque de France to 2.5%.

(374)   By December of 1930, industrial production in the U.S. had fallen 30%, 25% in Germany and 20% in Britain.  The U.S. had five million unemployed, Germany 4.5 million, with two million in Britain.  Commodity prices had collapsed across the world.  Coffee, cotton, rubber and wheat prices had dropped by 50% since the crash.  Three of the largest primary producing countries, Brazil, Argentina and Australia, had left the gold standard and let their currencies devalue.  In the industrial world, wholesale prices had fallen by 15% and consumer prices by 7%, yet the U.S. had not suffered a major financial disaster or bankruptcy.

(375)   After a brief revival in early 1930, U.S. investment to Europe dried to a trickle.  American bankers became risk averse, claiming creditworthy buyers were hard to find.  With American credit bottled up at home and demand for European goods shrinking, Europe could only pay for its imports and service its debts in gold.  During 1930, a total of $300 million in gold crossed the Atlantic into the vaults of the Federal Reserve System.

France also contributed to the world’s gold imbalance.  Keeping the franc undervalued made France’s exports cheap, and in order to buy the goods, foreigners first had to buy French francs, which eventually ended up as gold in her vaults.  In addition, this export driven economy remained healthy amidst the world crisis.  While Germany had 4.5 million unemployed, France had only 190,000.  And while prices around the world were dropping, in France they continued to rise.

(378)   Some commentators, especially the British, accused France of hording gold in contravention of the gentleman’s agreement regulating the gold standard.  By the end of 1930, the Banque de France held $1 billion in sterling and dollar deposits and $2 billion in gold.  Ordinarily, every franc of this would have created several new paper francs, but the inefficiencies of the French banking system combined with the "sterilization" policy of the French government resulted in the $500 million in gold that moved into French possession during 1930 was translated into only $250 million in new money.

But now for some commentary from Fritz the Cat:

This book purports to be about central banking, yet Ahmed, the author, steps rather lightly around the Dark Side of central banking.  Tip O’Neil once said that it was best not to look too closely as sausage or laws are made.  The same could be said of economics.  Ahmed is, according to the blurb on the dust cover, a professional investment manager for 25 years, has worked at the World Bank in Washington D.C., chief executive of New York based partnership Fischer Francis Trees and Watts (what the company does he does not explain), advisor to several hedge fund groups, and on the board of the Brooking’s  Institution.  He has degrees in economics from Harvard and Cambridge Universities, The blurbs on the back of the book are from Michael Beschloss and Strobe Talbott.  Ahmed represents the beating heart of the Eastern establishment and is "offering us a new understanding of the global nature of financial crisis", and the book "is a potent reminder of the enormous impact that the decisions of central bankers can have, their fallibility and the terrible human consequences that can result when they are wrong." Also on the dust cover.  

Fritz the Cat is a former construction worker and truck driver.  He doesn’t like looking at the Dark Side, but he does it anyway.  Ahmed would have us believe the central bankers were "fallible" and "wrong" intellectually, Fritz the Cat believes that "unintended consequences" are a smoke screen for the moral failure of men who seek wealth and power by any means necessary and the devil take the hindmost.

I broke off at France’s "sterilization" of gold, which Ahmed does not explain, but Fritz the Cat will be dropping out of this book and into a different book, one written not to give educated middle class liberals a story they can believe in, but a book written for professional economists.  I will quote from and summarize the sections on "fractional reserve banking" and "sterilization of gold" from the classic explanation of monetary economics: "A Monetary History of the United States, 1867 – 1960" by Milton Friedman and Anna Jacobson Schwartz.

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