The Dark Side Part IV Chapter I - Fritz the Cat

THE LORDS OF FINANCE Liaguat Ahamed Penguin Press N.Y. 2009

THE LORDS OF FINANCE Liaguat Ahamed Penguin Press N.Y. 2009
By the middle of 1931, Montagu Norman was the only remaining member of the original four central bankers that had restructured the financial world after WW I.  He led the British Central Bank. Benjamin Strong of the N.Y. Federal Reserve Bank had died in 1928 at the age of 55. Emile Moreau, of the Banque de France, had retired in 1930 and Hjalmar Schacht, of the German Reichsbank had resigned in a dispute with his government in 1930 and was flirting with Adolf Hitler and the Nazi Party.
In 1931, the world was in the second year of the unprecedented depression. In the two worst hit countries, Germany and the U.S., production had collapsed by 40%, and businesses had cut prices by 25% seeking to reach the few remaining buyers. In the U.S., unemployment was near 15%, with similar figures in the industrial world. In Germany, the Nazis increased their seats in the Reichstag from 12 to 107, making them the second largest party after the Social Democrats. There were coups in Portugal, Brazil, Argentina,Peru and Spain.
In December of 1930, the U.S. Bank failed. In May of 1930, the Austrian Credit-Anstalt, owned by the Rothschild family, failed, also. In July of 1931, the third largest German bank, the Danatbank, failed, leading to a run on other German Banks and the flight of capital from the country. The city of London, center of world finance, had lent heavily to Germany and now investors started withdrawing funds from London, forcing her to borrow from France and the U.S.
The latter half of the 19th century, an elaborate machinery of international credit, centered in London, had been built on the foundation of the gold standard, and brought with it a remarkable expansion of trade and prosperity across the globe. In 1919 that system lay in ruins. By the mid-20's, the four central bankers of the U.S., Britain, France and Germany appeared to have stabilized world currencies. Capital began flowing freely and economic growth resumed.
The 1920's were the end of one era and the beginning of another. Central Banks were still privately owned, their key objectives were to preserve the value of the currency and douse banking panics. In the latter part of the 19th century and the early part of the 20th, there was a great divide in the world of banking between the Anglo-Saxon banking firms on one side, and the Jewish ones on the other. They treated each other with wary respect, and shared a smug complacency toward the problems of their lesser, unemployment and poverty. John Maynard Keynes also participated in the drama of the times, albeit as a gadfly, from outside the charmed circle.

A central bank is a bank that has been granted a monopoly over the issuance of currency. This power gives it the ability to regulate the price of credit - interest rates - and hence to determine how much money flows through the economy. At the time, all major currencies were on the gold standard, meaning that their currencies were tied to a specific amount of gold, the pound sterling was defined as the equivalent to 113 grains of pure gold, and the U.S. dollar was defined at 23.22 grains of pure gold. Thus, the exchange rate between pounds and dollars was 113/23.22 or $4.86 to the pound. All paper money was legally obligated to be freely convertible into its gold equivalent. As of 1913, a little over $3 billion (some 25% of currency), consisted of gold coins, another 15% of silver coins and the rest, 60%, of paper currency. The majority, some 2/3 of a country's gold, was held in the vaults of the Central Bank providing the reserve of the banking system and determining the supply of money and credit within the economy. A country on the gold standard could only print more money, and thus stimulate the economy, if it first acquired the requisite quantity of gold. By 1914, 59 countries were on the gold standard.
The world's supply of gold is small and its production is erratic. During a drought in the supply of new gold, as happened in between the American and Australian gold rushes of the 1850's and the discoveries of gold in South Africa in the 1890s, the production of gold stagnated, while the production of commodities continued apace, meaning that an increasing supply of commodities must be purchased with a stagnant supply of money, causing the price of commodities to fall. Since credit is also a part of the supply of money, it also depends on the amount of gold held as a reserve in the Central Banks, during these droughts the supply of credit also dries up, raising its price.
The role of the gold standard is to control, inflation - the gradual loss of a currency's purchasing power. It can do nothing about the business cycle, which seemingly is due to man's two dominant emotions, greed and fear. Both are contagious, the sight of your neighbor making money triggering greed, and the sight of him losing money triggering fear. Since emotions are not rational, no rational means to eliminate the business cycle, including the gold standard, has yet been found. The biggest fear people with money in a bank had was seeing that bank close its doors. One such example spread fear to all banks, and the task of central banks became, in addition to controlling inflation, to maintain people´s trust in all banks.
On the afternoon of July 28, 1914, it was reported in London that Austria had declared war on Serbia over the assassination of Archduke Franz Ferdinand, presumptive heir to the Austrian Empire. By July 30, Russia had ordered a general mobilization, and the international political crisis brought a financial crisis in its wake. The Berlin, Vienna, Budapest, Brussels and St. Petersburg stock exchanges all had to suspend trading, and a panic liquidation of securities concentrated on London.
London was the financial capital of the world. Every year, a billion dollars of foreign bonds were issued through London banks. This would dry up in the event of war. The merchant banks that had guaranteed trade debts faced bankruptcy if gold could not be shipped abroad to settle debts, as seemed likely. On July 30, the British stock exchange was closed until further notice for the first time since its founding in 1773.
For the previous six months a fierce debate as to the adequacy of Britain's gold reserves between the city of London' s commercial banks and the Bank of England that had gone on over the assumption that in the event of war, foreign nations could cash in their pounds sterling and demand gold. In the event it was London's commercial banks who began withdrawing gold from their accounts. The Bank of England ' s bullion reserve fell from $130 million on Wednesday, July 29 to less than $50 million on Saturday, August 1, when the bank raised its interest rate to an unprecedented 10% to attract depositors and conserve its rapidly diminishing stock of gold.
Germany mobilized on July 31, and on August 1st declared war on Russia. Also on August 1, France mobilized, and given alliance with Russia, would be at war with Germany soon. In London, the common people inclined to war, and the bankers were on the edge of panic. A bank holiday was extended three days, and all trade debts were extended one month.
Hjalmar Schacht, who would later become the head of the German central bank, was at the time a well established mid-level officer in one of the powerful Berlin banks. Like most other German bankers and businessmen, he believed that the villain was a fading Britain conspiring to deny Germany its rightful place among the Great Powers. On August 3, Germany declared war on France and the next day invaded through Belgium, whose neutrality Britain had guaranteed, involving Britain in the war. There was a run on German banks, but little demand for gold, and the Reichsbank lost only $25 million of its $500 million in gold reserves in the first few days. They had suspended the convertibility of the mark into gold on July 31.
The summer had been quiet on Wall Street after a bull market that had stretched through the first few years of the century; stocks had been flat for almost four years and the volume of trading was low. When Austria declared war on Serbia on July 28, 1914, the DOW fell by 4%, and on July 30, when Russia mobilized her troops the DOW fell by 7%, the largest single day loss since the panic of 1907.
On July 31, the banks controlling the New York Stock Exchange closed it. The United States was the largest importer of capital in the world, most of it corming from Europe, and the bankers greatly feared that the loans that came due in the next few months, usually rolled over, would instead be called in as the European's money found use at home.

The then current U.S. central bank had been in existence for less than four years. The two previous central banks had been allowed to expire after their twenty year charters ended, in 1811 and 1836.  In the seventy year interregnum financial crises had been handled by the banks themselves, but the 1907 crisis caused by the over speculation and collapse of a single bank, focused attention on the growing need of a U.S. central bank.
In 1908 the U.S. Congress created the National Monetary Commission, nine senators and nine representatives chaired by Senator Nelson Aldrich. By 1912, Henry Davidson, right-hand man of J.P. Morgan, and senior partner of the House of Morgan banking trust, feared that the lack of activity could go on until it was too late, and convened five other men to submit a plan to the government:  Senator Aldrich; A. Latte Andrew Jr., the assistant secretary of the treasury; and three of the best bankers in the U.S., Paul Warburg, Frank Vanderlin and Benjamin Strong.
Their plan called for sort of a banker's cooperative, but Midwest Republicans and Progressives thought it too centralized and killed the measure. Senator Carter Glass modified the idea in early 1913, proposing a number of autonomous regional institutions in place of the single central bank of the Aldrich plan. The New York bankers feared this would lead to conflict and confusion, but realized that it was better than the status quo and came around. It was signed into law as the Federal Reserve Act by Woodrow Wilson on December 23, 1913.
The New York banking community had had its eyes on Benjamin Strong as a potential head of the Aldrich committee's central bank. Now, with the Federal Reserve System´s multiple reserve banks and a Board in Washington, they decided the place for him was at the head of the Federal Reserve Bank of New York.
Toward the end of July, 1914, the headline of the French papers, previously dominated by several juicy scandals, began to take notice of events in the Balkans. Gold coins started disappearing from circulation, and businesses began refusing paper money. By the afternoon of July 28, over 20,000 people lined up outside the national bank to exchange paper money for gold. The bank was not alarmed, France had the single largest hoard of gold in the world, over $800 billion in bullion.
By August 29, the Germans were within 25 miles of Paris. Had they captured Paris and opened the Bank of France's vaults, they would have found them empty. Paris had fallen to foreigners three times in the past 100 years. By August 18, 1,300 tons of gold ingots and coins had been shipped in great secrecy to vaults in the Massif Central and the south of France.
Financial circles throughout Europe predicted the war would last six months to a year, because that was the various estimates of how long the gold would last that necessarily had to pay for it, forgetting that sound finance is always one of the first casualties of war. By 1916 the five major powers, Britain, France, Russia, Germany and Austria-Hungary - were spending $3 billion a month, nearly 50% of their collective GDP. This money was raised primarily by borrowing, and after every conceivable source of borrowing had been exhausted, by simply printing more currency, the gold standard universally abandoned, currency in circulation doubled in Britain during the war, tripled in France, and quadrupled in Germany.
The U.S. experienced an enormous boom during the war due to European demand for materials and supplies. In addition, the uncertainties in Europe led to the swelling of bullion reserves from $2 billion to $4 billion in the U.S., also doubling the U.S. credit and money supply. To Benjamin Strong, head of the New York Federal Reserve Bank and dominating figure in discussions of monetary and financial policy, this was not an unalloyed boon. On the one hand, he feared destabilization if the gold all flowed back to Europe at the end of the war, and on the other hand he feared that if the gold stayed in the U.S., there would be a shortage of reserves in Europe and the possibility of even greater inflation at home. Strong recognized that a coordinated effort with the European Central Banks would be required, and in February 1916 he went on a scouting trip to Europe.
Strong's great task when the U.S. entered the war in 1917, was to raise the money to pay for it. The U.S. spent $30 billion on the war, $20 billion on actual expenditures and $10 billion worth of war loans to allies. The government made an aggressive effort to induce the American public to purchase war debt by buying Liberty Bonds. Close to $20 billion was raised this way, half by the New York Federal Reserve. Strong's presence at so many of these fundraisers made him a minor celebrity.
The Fed emerged from the war a changed institution. It had resisted the European practice of purchasing government bonds and only indirectly helped fuel the expansion of the money supply, securing it some creditability. More importantly, the war had changed entirely the financial position of the U.S. It now had the largest reserve of gold bullion in the world.