n the early days after the crash of 1929, Andrew
Mellon-then Secretary of the Treasury and one of the wealthiest men
in the United States-gave the following advice to President Hoover:
"Liquidate labor, liquidate stocks, liquidate the farmers,
liquidate real estate ... purge the rottenness out of the system."'
At about the same time, Russell Leffingwell of Morgan offered his
prescription for how to get the economy out of the depression: "The
remedy is for people to stop watching the ticker, listening to the
radio, drinking bootleg gin, and dancing to jazz ... and return to
the old economics and prosperity based upon saving and working.
112
The sins of the speculators were to be laid upon the children, as the Shakespearean proverb goes,' but in this case they were also to be laid upon the sinners themselves, to say nothing of the millions of innocents caught up in the whirlwind by circumstances beyond their control. No one was to be allowed to escape the choking grip that the process of deflation cum moral redemption was to impose.
Mellon and Leffingwell were far from alone in expressing these themes. On the contrary, their views encapsulated the conventional wisdom of the times: the rallying cry for deflation and purge would recur in many variations but with a terrible and oppressive monotony. That was by no means the worst. The policymakers-the central bankers as well as the leading politicians-would actually follow this advice as they faithfully translated these grim turns of phrase into policy decisions at every level and in every country. When viewed from the perspective of the past sixty years, these people seemed to be speaking the language of another planet.
There were a few brave souls who were convinced that it was the entire economic system that suffered from looming maladjustments, not the morals of the players in the stock market. These men argued that the way out of the Depression was to attempt to short-circuit the misery, not intensify it. They sought means to reliquefy the tottering banking system and somehow put money into people's pockets so that they would be both willing and able to go out and spend it. They found themselves either talking to a brick wall or facing such vigorous opposition that in time they gave up and retired from the fray.
One of these was Herbert Hoover himself. Hoover was shocked by Mellon's advice, especially as "Mellon was not hard-hearted. In fact he was generous and sympathetic with all the suffering."a Mellon's error, Hoover wisely pointed out, was his insistence that this was "just an ordinary boom-slump," which led him to underestimate the seriousness of the European situation. Nevertheless, Hoover's efforts to be pro-active were far too modest in scale to stem the cyclone sweeping around the world. Nor did he ever abandon the conventional notion that people could not look to government to solve their problems, no matter how helpless they felt. Sounding rather like Ronald Reagan fifty years laterunder radically different circumstances-Hoover reminded his audience in a radio address on February 12, 1931, that:
The evidence of our ability to solve great problems outside of government action and the degree of moral strength with which we emerge from this period will be determined by whether the individuals and local communities continue to meet their responsibilities.... Victory ... will be won by the resolution of our people to fight their own battles ... by stimulating their ingenuity to solve their own problems, by taking new courage to be masters of their own destiny in the struggle of life.'
Another believer in positive action was George Harrison, Benjamin Strong's successor at the Federal Reserve Bank of New York.* Within days of the crash, Harrison proposed that the Federal Reserve banks should buy government securities in the open market to inject some liquidity into the system. Harrison believed this strategy was essential in order to satisfy the insatiable demand for money-the only asset that households, corporations, and financial institutions wanted to own in the panic environment. Bank lending had been clamped shut, forcing commodity prices to collapse, which led in turn to proliferating bankruptcies and bank failures.6 As jobs were vanishing by the millions, Harrison did make a few brief efforts on his own to conduct open-market purchases at the New York Federal Reserve, but once again the Washington authorities and the presidents of the other Federal Reserve banks frustrated Harrison and his staff by calling a halt to such "inflationary" activities.
Poor Harrison-when the United States began to lose gold during the autumn of 1931, even he abandoned his expansionary views and fell into line with the mainstream views. Now he promptly agreed with his colleagues that the only proper policy under such conditions was to raise interest rates-and to raise them by a lot. Eugene Meyer, Chairman of the Federal Reserve Board in Washington and one of Harrison's few supporters in his earlier notions, hastened to agree, declaring that the sharp increase in interest rates "was called for by every known rule, and that ... foreigners would regard it as a lack of courage if the rate were not advanced."7
At this moment, wholesale prices in the United States were already 24 percent below 1929, unemployment was climbing to over 15 percent of the labor force, and three thousand banks had failed. There was no such thing as deposit insurance in those days, which meant that depositors lost every dollar that they had on deposit at every bank that failed. This money simply disappeared into thin air. As the Federal Reserve drove interest rates even higher, prices would drop by another 10 percent, unemployment would reach 25 percent of the labor force, and over three thousand more banks would fail."
Meyer was without doubt correct: the contractionary policy was called for by every known rule. Meyer's analysis reveals how profoundly the basic mindsets of the gold standard dominated policymakers far into the Depression-a situation that even Herbert Hoover recognized as something never before confronted in all of history. Politicians, monetary authorities, business leaders and bankers, and even most academics continued to genuflect before the gold bricks as though these gleaming hoards were all that mattered. They forgot that this was also the stuff that the Parthians had poured down the throat of Crassus after he had been defeated in battle.
The resulting infectious epidemic of disasters only strengthened the obstinate faith in the traditional approach. Indeed, as export trade shriveled in country after country, there seemed to be no choice but to restrain demand in order to hold down imports. Failure to act along those lines would be certain to lead to the most dreaded result: losses of gold to other nations. The vivid example of how gold had tortured the British economic system into deflation since 1925 was there for all to see, but Britain's path appeared to be the sole available roadmap to follow in managing the cataclysm of the 1930s. Although deflationary pressures were coming down so hard on Germany that Adolf Hitler would one day come roaring into power, and although mounting unemployment and spreading bank and business failures throughout the world were tearing into the deepest roots of the capitalist system, these horrors served only to strengthen the determination to preserve gold reserves above all else. The known rules defined the one safe policy when everything else was out of control.
Events during the first year after the Great Crash were disturbing, but 1930 in retrospect looks in many ways like the calm before the storm. On March 7, President Hoover reported that "All the evidence indicates that the worst effects of the Crash upon unemployment will have passed during the next sixty days." This was not a bad forecast under the circumstances. The domino effect of a major crisis would not make itself felt until the end of 1930, first with the failure of Caldwell & Co., a bank in Tennessee that brought down industrial companies, insurance companies, and small commercial banks in its wake, and then with the failure of a small New York bank with a big name, the Bank of United States. Some 2300 banks would follow suit over the next few months."' In Britain, the primary consequence was a series of significant losses of gold. On January 13, Norman had already warned the Chancellor of the Exchequer that he could no longer postpone the unpleasant task of raising interest rates.
The fuses were in place. They were lit on May 11 when the explosive news of the failure of the Creditanstalt Bank in Vienna stunned the world. This was Austria's largest commercial bank by far, holding more than half of all Austrian bank deposits. Today we would call the Creditanstalt an institution too large to fail. It was too large to fail in 1931, too, and the Austrian government had to bail it out. But to no avail. The Creditanstalt failure, in the words of the British Treasury official Ralph Hawtrey, "sent a terrible spasm of panic through the financial centers of the world."" The spasm first ignited a run on the other Austrian banks and then panic hit the schilling in the foreign exchange markets. In desperation, the Austrian National Bank tried to borrow foreign exchange from other central banks. The Bank of France insisted that no loans would be possible unless the Austrians renounced their intention to form a customs union with Germany, which the Austrian government refused to do. Meanwhile, the Bank of France, busy substituting gold for deposits in foreign central banks, acquired $539 million of gold-about 25 percent more than the entire year's production of gold at the mines.12 Nevertheless, Montagu Norman, still fighting his personal war against the French, succeeded in infuriating his enemy once more by going ahead with a loan to the Austrians from the Bank of England.
It was too late. Everything was now focused on protecting the golden stockpiles from further damage. Norman's modest efforts would prove to be nothing more than a transitory stopgap. In short order, the run on Austria provoked runs on Hungary, Czechoslovakia, Romania, and Poland. These panics were sufficient to disseminate alarm to still other countries, with the most serious repercussions coming down on Germany.
The knee-jerk response by the German Chancellor, Heinrich Bruning, was to slash government spending. Bruning tried to offset the fury unleashed by the additional unemployment and deflationary pressure he was creating by proclaiming that Germany had reached the limit of its ability to pay reparations. His statement may have been welcome at home, but it led the flight from the reichsmark to begin in earnest. The crisis became so threatening that on June 19 President Hoover, at Leffingwell's suggestion, proposed a one-year moratorium on both German reparation payments and payments by the Allies to the United States for war debts. The French were furious at this concession to the Germans and refused at first to take part in any discussions. Although temporary credits were arranged for Germany, the haggling went on for so long over the Hoover proposal that the panic started up all over again and the German hemorrhage of gold and foreign exchange accelerated. In an effort to contain the damage, the Germans began the imposition of a system of controls on foreign exchange transactions that became so tight and so complex that by 1932 Germany effectively ceased to be on the gold standard.
The crisis in central Europe rapidly communicated itself to the pound, in large part due to the actions of the French. Britain now began to suffer sharp losses of gold and heavy withdrawals of foreign-owned sterling balances. The sterling crisis was all the more remarkable because prices in Britain had already fallen 38 percent from the level in 1925 when the gold standard had been reestablished. 13 The situation appeared to be so desperate that Winston Churchill, on vacation in Biarritz, blurted out, "Everybody I meet seems to be vaguely alarmed that something terrible is going to happen financially. I hope we shall hang Montagu Norman if it does. I shall certainly turn King's evidence against him. 1114
Norman, in fact, seemed to be as lost as anyone. When Harrison at the New York Federal Reserve Bank cabled him on July 15 that "We are concerned and surprised at sudden drop in sterling today," Norman's response was, "I cannot explain this drop. It was sudden and unex- pected."15
One can only wonder at the way Norman ducked Strong's query. Two days earlier, the publication of the final report of the findings of a special governmental committee had disclosed the alarming deterioration in the condition of Britain's foreign trade position, with imports exceeding exports by an ever-widening margin. An even more immediate source of trouble was also coming to a head. London financiers had been borrowing at low interest rates in Paris and lending the proceeds to the Germans at much higher rates of interest, but now French financiers uneasy about the outlook for the pound were demanding repayment of their loans to London. The shocking sum of some 0750 million was involved.16
This turn of events was too much for Norman. On July 28, exhausted by the sequence of defeats to all his hopes and dreams, he went home from the Bank "feeling queer."" After a week in bed, he sailed to Canada for a vacation of total rest. The last act of the drama that he had largely written and directed was about to play itself out without him. We will never know whether he was too sick to deal with the crisis or just unable to face the total failure of his efforts that loomed just ahead.
Two days later, the Treasury issued an alarming report on the state of the government's burgeoning budget deficit. The deficit for 1932 was now projected to be (170 million, which was k50 million above the previous estimate. The news shook the entire financial world. No one understood why the report had to be published at that most sensitive moment; Keynes characterized it as "the most foolish document I have ever had the misfortune to read."'s
As the exodus of Britain's stock of gold persisted, sentiment was building for the government to take drastic action to put its financial house in order. The state of the economy made the task extremely disagreeable: by August, nearly one in four workers was unemployed, up from one in six a year earlier, while prices and wages continued to fall. The Economist of August 22 chose this moment to declare that Britain was living beyond its means, that the budget must be balanced, and that "every extravagance in dole [relief payments to the unemployed] and other expenditures should be eliminated." That kind of talk had gone on intermittently ever since the war, but this time it was not just talk. Nevertheless, with the Labour Party in power, headed by Ramsay MacDonald, the decision to cut the dole was turning out to be even more agonizing than if the Tories had been leading the government. Another emergency effort was undertaken to borrow from French and American bankers, including J. P. Morgan, but the bankers refused further credits without the imposition of budget cuts deeper than the government could accept, especially in the dole. Word of the bankers' conditions caused "pandemonium" in the Cabinet room.19
Yet something had to be done. On August 24, King George invited MacDonald to form a National Government, a coalition of Labour, Liberal, and Conservative parties, to make the pain of the budget cuts more politically palatable. The tonnent suffered by the country's leaders is vividly illustrated by a letter dated September 12 from the King to the Prime Minister, which MacDonald read aloud to Parliament in an emergency session. His Majesty expressed the desire "in the grave financial situation with which the country is confronted personally to participate in the movement for the reduction of national expenditure." The King proposed to forgo k50,000 a year in his annual allowance, a reduction of about 10 percent. Hailing the King's offer-and evoking the noble sacrifice of Dickens's Sidney Carton-MacDonald proclaimed that "It is far, far better for all of us to go with tight belts into stability than with loose ones into confusion." He went on to express his determination to perform in accordance with this credo by assuring the country that he would keep Parliament in emergency session until "the world is convinced once again that sterling is unassailable."'"
It was a good thing that no one bothered to hold MacDonald to his promise. If they had, Parliament would still be sitting in that same emergency session.
Keynes's was a lonely voice in opposition to the mainstream thinking that only thrift could cure the world's awful economic diseases. "Suppose we were to stop spending our incomes altogether and were to save the lot," he suggested in a radio broadcast in January 1931. "Why, everyone would be out of work.... Therefore, oh patriotic housewives, sally out tomorrow early into the streets and go to the wonderful sales which are everywhere advertised. You will do yourselves good-for never were things so cheap.... And have the added joy that you are increasing employment [and] adding to the wealth of the country because you are setting on foot useful activities.""
Keynes's logic may have made sense to the patriotic housewives, but it had no effect on the intentions of the nation's political leaders. The National Government's Budget and Economy Bill provided for a £70 million reduction in government spending and a tax increase of r86 million. Keynes lost no time in characterizing this legislation as "replete with folly and injustice." Nevertheless, the Government was convinced that the defense of sterling was the primary objective, regardless of human cost in Britain. As a further lure to foreigners to hold sterling, the Bank Rate-the rate charged by the Bank of England to banks needing immediate credit-had been raised in a giant leap to 6 percent from 2%z percent in June. The combination of higher taxes, reduced spending, and higher interest rates was lethal. The economy sank even lower and unemployment rose even higher, pulling tax revenues down along with the shrinking payrolls and profits. In the end, the government was left with a much larger deficit than the experts had predicted.
Before the Economy Bill had much opportunity to rescue the pound, a bizarre but shocking event occurred while the debate on the legislation was under way, a strange echo of the invasion of Fishguard in February 1797. A small contingent of sailors at the British navy station of Invergordon went on strike against the pay cuts that were part of the proposed legislation. The press, both at home and abroad, gave the pocket mutiny huge black headlines. Foreigners received the news in a state of high alarm: if such a thing could occur in the British navy, of all places, the whole country must be on the verge of revolution. Nearly L40 million of gold was swept out of the Bank's vaults in a single week; X200 million had been lost since the middle of July.
By the third week of September, the jig was up. The Bank of England asked the government to relieve it at once of the obligation to provide gold bullion on demand, an obligation that had been in place a mere six years. The requisite legislation passed the House on September 21. The Economist announced "The End of an Epoch." Unwilling to admit the consequences of the Norman Conquest of $4.86, the magazine put the blame on "the slump that followed the extravagances of the American boom [which] showed up in all their crudity the various defects which have prevented the gold standard from working properly and led to trade depression." Keynes's observations on September 27 were more to the point; he looked forward rather than backward. "There are few Englishmen," he wrote, "who do not rejoice at the breaking of the golden fetters. We feel that we have at last a free hand to do what is sensible.... I believe that the great events of the last week may open a new chapter in the world's monetary history. I have a hope that they may break down barriers which have seemed impassable."•22 The most poignant comment came from Tom Johnson, a former Labour Minister, who said, "They never told us they could do that."23
A few days before these events, feeling much improved and ready to go back to work, Norman had sailed from Canada on a ship bound for home; he was totally unaware of the grand denouement of all his endeavors that lay just ahead. His colleagues at the Bank felt obliged to let him know about the momentous decision that was about to go into effect in his absence, but they did not want the news to leak out ahead of time. On the Saturday before the Monday on which the official announcement was to be made, and referring to the Old Lady of Threadneedle Street-the favorite nickname of the Bank of Englandthey cabled Norman, "Old Lady goes off on Monday." Poor Norman was so spaced out that he thought they were referring to his mother's plans for a vacation.24 Did he get a shock when the ship landed at Southampton!
The pound, no longer convertible into gold, took a steep tumble in the foreign exchange markets during the next three months. Foreigners who held sterling on September 21, the day that Britain broke loose, could now convert their pounds into only $3.75 instead of $4.86-a major loss; in December it would touch $3.25. Central bankers around the world rapidly lost their appetite for holding their reserves in the currencies of other countries, even the almighty dollar itself. There were to be no substitutes for gold.
Twenty-four out of the 47 nations on the gold standard immediately raced down the path that Britain had just blazed through the thickets of economic chaos: they suspended convertibility into gold within days of the British action. A year later, only the United States, France, Switzerland, Holland, and Belgium remained on the gold standard; six years later, not a single country permitted their citizens to convert their currency or bank deposits into gold.25 The golden hoards were to be defended by rendering them inactive!
The dash toward gold hit America hard. This urgency to get out of dollars was a surprise, for the official U.S. gold stock at that moment amounted to $4.5 billion-over 40 percent of the gold reserves of all central banks and treasuries around the world and 65 percent larger than France's gold holdings .26 Nevertheless, on September 22, 1931, the Belgian national bank pulled $106 million in gold from New York in one fell swoop; France took $50 million on that day and another $70 million a few weeks later. From the end of September to the end of October, a total of $755 million in gold flowed out of the United States, of which nearly half went to France and the rest mainly to Belgium, Switzerland, and the Netherlands. About one in every seven gold bricks in the vaults of the Federal Reserve banks had departed.27 The panic induced by this news led Americans to follow suit by making massive withdrawals from commercial banks in the form of currency and gold coin, leading almost at once to another eight hundred bank failures.
The prescription for dealing with this crisis was once again the conventional one: deflate and create unemployment. The Federal Reserve lost no time in more than doubling the Discount Rate, boosting it in one giant step from 1'h percent to 3% percent. The prescription performed as expected. The gold outflow ceased-for the moment. Deflation and the creation of additional unemployment were also successfully achieved. Manufacturing production, already down by a third from 1929, sank by an additional 25 percent over the next nine months. Unemployment doubled from a worrisome 10 percent of the labor force to well over 20 percent, while wholesale prices dropped by 25 percent and would end up in 1932 almost 40 percent below their 1929 levels.
At this point, hoarding of currency and coin by the public was restricting even further the ability of the banks to provide credit to their customers. In the middle of 1930, Americans had held $11 in bank deposits for every dollar of currency in their pockets and cash registers, but this ratio dropped over the next twelve months to only $6 in deposits per dollar of currency.2s President Hoover then invited Colonel Frank Knox of Chicago to conduct an educational campaign to discourage the hoarding; Knox must have been quite a salesman, for his pitch served at least to slow the rate of decline in the ratio for a while .*
The savage deterioration in economic conditions forced the Federal Reserve authorities to conclude that they had pressed the policy of deflation far enough. Positive action could no longer be postponed. In the spring of 1932, the Reserve banks bought $1 billion of government securities, a move that Ralph Hawtrey, the British Treasury economist, characterized as "heroic."s" Although the May 30, 1932, issue of Time magazine had placed a photograph of Federal Reserve Chairman Eugene Meyer on the cover (and included a surprisingly technical discussion of Federal Reserve operations in the government securities market), the billion-dollar purchase would prove to be little help to the economy. A fresh wave of anxiety and uncertainty broke out, prompted by concerns that the Federal Reserve was acting to promote inflation. The heroic step simply led to a renewed outflow of gold.
Now began a chilling replay of the events that had led to the final crisis of the British government in 1931: frantic efforts to extinguish a swelling budget deficit as tax revenues shriveled while the demand for government assistance to the unemployed increased in urgency. A deficit of $2 billion was estimated for the fiscal year ending in June 1932, over 3 percent of the total national output (an astonishing number for its time); the actual figure would exceed that amount.31 Following dutifully in the footsteps of Bruning and MacDonald, Hoover pressed Congress to act to reduce this forbidding deficit by cutting expenditures and raising taxes. "Rigid economy is a real road to relief to home owners, farmers, workers, and every element of our population," he assured Congress. "Our first duty as a nation is to put our governmental house in order. 1132
Hoover's determination in this matter was inexhaustible, but Congress was less motivated than the President for such noble objectives. Their spending cuts and tax increases were well below what Hoover sought. Nevertheless, the economic impact of these measures added to the prevailing deflationary pressures and led to an even greater budget deficit in 1933.
And so matters wobbled along until the election of November 1932, when the Democratic candidate, Franklin D. Roosevelt, defeated Herbert Hoover in a landslide. The moment for action to revive the economy had not yet arrived, however, because in those days the inauguration took place on March 4 rather than January 20. A lame-duck President and Congress continued in place for four long months.
Despite untiring efforts to induce Roosevelt to work with him, Hoover complained again and again to the public about Roosevelt's flat-out refusal to cooperate in any measure whatsoever until Roosevelt had been inaugurated and was in power.33 One of Hoover's most protracted efforts to engage Roosevelt's participation concerned plans for a major international economic conference on the world depression and the war debts. Hoover pleaded with Roosevelt:
Ever since the storm began in Europe, the United States has held staunchly to the gold standard.... We have ... maintained the one Gibraltar of stability in the world and contributed to checking the movement of chaos.... [A] mass of gold dashing hither and yon from one nation to another, seeking maximum safety, has acted like a cannon loose on the deck of the world in a storm.... Confidence cannot be reestablished by the abandonment of gold as a standard in the world.34
Even these strong words failed to persuade Roosevelt to cooperate. As a result, it was a rough four months up to the inauguration, with uncertainty growing as to what actually would lie ahead after the new president was installed. Roosevelt's campaign promise that the government would provide jobs for all the unemployed had the perverse effect of creating a new wave of unemployment by businessmen frightened by fears of socialism and reckless government spending.
Rumors were soon circulating that the new administration would begin "tinkering" with the currency. On January 2, 1933, thirty prominent economists expressed their alarm and insisted that "The gold standard of present weight and fineness should be unflinchingly maintained ... agitation and experiments would impair confidence and retard recov- ery."3s In a clear state of alarm, the famous financier Bernard Baruch, who had supported Roosevelt, told a Senate committee on February 13 that inflation was the road to ruin and that "If you start talking about [devaluation] you would not have a nickel's worth of gold in the Reserve System day after tomorrow."36
These exhortations only added to the spreading fear, but the litany on maintaining the gold standard resumed in the press, among leading members of Congress, and from George Harrison of the New York Federal Reserve himself. On January 31, however, Henry Wallace, who had been mentioned as a member of the new Cabinet, flew in the face of orthodoxy by declaring that "The smart thing would be to go off the gold standard a little further than England has." On February 18, the press announced that Senator Glass, one of the foremost experts on gold and currency in the Congress, had refused Roosevelt's invitation to be Secretary of the Treasury because the President-elect would not give him satisfactory assurances on maintaining the gold standard.37
Frightened Americans now joined agitated foreigners in seeking safety by moving their capital abroad or into gold. A renewed run on the U.S. gold stock resulted in $160 million leaving for foreign climes in February 1933 and another $160 million in the first four days of March that led up to Roosevelt's inauguration. The mounting panic included withdrawals of gold coin from the commercial banks, with over $80 million going out in the last ten days of February and over $200 million during the first four days of March.38
The Harvard Trust Company survived, but thousands of other banks hit by runs on their deposits did not. Over ten thousand banks disappeared from the scene during 1933, by which time the total number of banks in the United States had fallen to fewer than ten thousand from thirty thousand in 1925 and about 25,000 in 1929.39 The frantic liquidation of bank accounts had driven the ratio of bank deposits to currency in circulation into a precipitous drop from $6 of deposits for every dollar of currency in circulation at the end of 1932 to only $4 for every dollar of currency in March 1933 just about one-third of what this ratio had been before 1929.4"
Where was the Federal Reserve while all of this was going on? The eminent economists Milton Friedman and Anna Schwartz provide an answer to this question in their monumental monetary history of the United States: "The System was demoralized [and] participated in the general atmosphere of panic that was spreading in the financial community and the community at large. The leadership which an independent central banking system was supposed to give to the market ... [was] conspicuous by [its] absence."41
On March 5, the day after the inauguration, the new Secretary of the Treasury assured the country that the gold standard was inviolate. Over the next couple of days, the press both at home and abroad joined in repeating these sentiments. On March 8, Roosevelt held his first press conference and declared that the gold standard was safe.
So much for that. On March 9, Roosevelt pushed the Emergency Banking Act of 1933 through both houses of Congress, authorizing him to regulate or prohibit the export or hoarding of gold or silver and empowering the Secretary of the Treasury to require the surrender of all gold coin, bullion, and certificates (paper notes fully secured by gold) held by the public.42 The public perceived the March 9 legislation as temporary! Anxiety eased, and gold and paper currency started to return to the banking system.
Everything seemed just fine for a few weeks, until the market began to suspect that Roosevelt really did plan to cut the gold value of the dol lar. He had made no secret of his intention to stem the deflationary cycle and start prices back upward, because he was confident that bold steps in that direction would encourage business to start rehiring and increase the depressed level of production. As the rumors about gold proliferated, the run on the dollar resumed, and with good reason: on April 18, legislation was passed giving the President wide powers over the economy, including a reduction in the gold content of the dollar.
Hoover's memoirs are unsparing in their slashing attack on Roosevelt's policies. Hoover claimed that abandonment of the convertible gold standard was the first step toward "communism, fascism, socialism, statism, planned economy." Gold, he argued, is essential to prevent governments from "confiscating the savings of the people by manipulation of inflation and deflation." He goes on at length in this vein; in a footnote, he quotes an old proverb: "We have gold because we cannot trust Governments."43
Roosevelt was determined to proceed. On April 5, only a month after his inauguration and acting under the authority of the Trading with the Enemy Act of 1917 and the Emergency Banking Act passed in March, he issued an executive order requiring all persons to deliver all gold coin, gold certificates, and bullion to the banks in exchange for paper currency or bank deposits, and for the banks to deliver the gold to the Federal Reserve. According to Hoover, only about $400 million in gold came into the banks, adding less than 10 percent to the existing gold stock.
Further enabling legislation in April gave the President the authority, among other things, to fix the weight of gold in the dollar at not less than 50 percent or more than 60 percent below the weight that had established an ounce of gold at $20.67 in 1837, nearly one hundred years earlier. This act prompted Lewis Douglas, Director of the Budget, to predict that "This is the end of Western civilization."44 There was more to come. Further congressional action on June 5 provided that any clause in any contract that provided for payment in gold was now abrogated-even including obligations of the U.S. government.
The cancellation of the gold clause in U.S. government obligations resulted in a rash of lawsuits that ended up in the Supreme Court. The Court agreed that Congress had no right to cancel the promise to redeem its debts in gold at the option of the holder. But then the justices went on to declare that, since the private ownership of gold coin was no longer legal, the plaintiff's demand for damages equal to the change in the gold value of the dollar from $20.67 to $35.00 was without merit!45
On July 3, Roosevelt issued a statement-which came to be known as the "bombshell" message-declaring that efforts to stabilize exchange rates by going back to rigid relationships to gold were "old fetishes of so-called international bankers" and that exchange-rate stability was "a specious fallacy."46 The statement scandalized most conservative politicians, financiers, and academic experts, but the President did find one supporter when John Maynard Keynes proclaimed "Roosevelt magnificently right!" Raymond Moley, one of the President's chief advisors, subsequently quipped, "Magnificently left, Keynes means. 1141
The dollar was now varying from day to day in the foreign exchange markets as Secretary of the Treasury Morgenthau followed Roosevelt's order to gradually reduce the amount of gold a dollar could buy-or, stated differently, to increase the number of dollars required to buy an ounce of gold. Secretary Morgenthau's diaries recite a famous anecdote from this period, as he and two other officials would meet each morning in the President's bedroom to set the price for gold for the day:
Franklin Roosevelt would lie comfortably on his old-fashioned threequarter mahogany bed.... The actual price [of gold] on any given day made little difference. Our object was simply to keep the trend gradually upward, hoping that commodity prices would follow. One day, when I must have come in more than usually worried about the state of the world [Hitler had just recently come to power in Germany], we were planning an increase of from 19 to 22 cents. Roosevelt took one look at me and suggested a rise of 21 cents. "It's a lucky number," the president said with a laugh, "because it's three times seven...."
He rather enjoyed the shock his policy gave to the international bankers. Montagu Norman of the Bank of England, whom FDR called "old pink whiskers," wailed across the ocean, "This is the most terrible thing that has happened. The whole world will be put into bankruptcy." The president and I looked at each other, picturing foreign bankers with every one of their hairs standing on end with horror. I began to laugh. FDR roared.41
For once, Keynes sided with his traditional adversary Norman and refused to join in the fun. He described the gyrations of the dollar "like a gold standard on the booze."49
The game came to an end on January 30, 1934, when an executive order fixed the price of gold at $35.00 an ounce, an increase of 69 percent from the old value. That price would prevail without interruption for 37 years, which was three years longer than the dejure value of $20.67 set in the Gold Standard Act of 1900. Although many other factors were at work, it is worth noting that from 1933 to 1937 industrial production jumped by 60 percent and wholesale prices climbed 31 percent while unemployment fell from 25 percent to 14 percent. By early 1937, the Dow Jones Industrial Average stood at 200, a mighty surge from its nadir at 40 touched during the darkest days of 1932. Happy Days were here again!
Except for the French, the Swiss, the Dutch, and the Belgians, who remained nailed to the cross well into the 1930s. The Dutch and the Belgians clung to their 1913 parities right up into World War II. The French franc, which had once made French goods look so cheap relative to British goods after it was stabilized in 1925, appeared increasingly expensive after the pound broke loose from gold in 1931. The French then caught a bad case of the deflationary disease from which the rupture from gold had liberated Britain and the United States. Prices in France fell by nearly 25 percent between 1931 and 1935, while French national income dropped by a third.""
By 1936, the horrors had reached the stage where France was besieged by angry sit-down strikes. The political chaos led to the formation of a Popular Front government that included Communists and Socialists-not the most appropriate combination to restore international confidence in the franc. The break from gold and the devaluation of the franc occurred in September under cover of a Tripartite Agreement with Britain and the United States. This agreement added up to little in the way of action but did at least restore international cooperation to something better than the endless friction and backbiting that had characterized international financial relations since the end of World War I.51
Meanwhile, something strange was happening to gold. As each currency broke away from gold and was devalued, a unit of each currency bought less gold than before-that is, the price of gold went up, as it had risen from $20.67 to $35.00 in the United States. In contrast, the prices of goods and services in all countries had fallen by substantial amounts. The result was that an ounce of gold in the mid-1930s could buy twice as many goods and services as that same ounce could have bought in 1929.11
In a world in which production was deeply depressed for just about everything that people desperately wanted but could not afford-food, clothing, housing-this leap in the price of gold was a bonanza for gold miners and the equivalent of a whole new gold rush for the world economy. Gold production soared. This new gold came primarily from South Africa, although, as in the past, Russia remained an important producer. In addition, Asia-beset by the Great Depression like everyone elsefor the first time in history dishoarded gold and shipped about $100 million westward. In 1932, the two million tons of gold coming out of the world's gold mines amounted to nearly half of all monetary gold accumulated from the beginning of time to the middle of the nineteenth century. In 1938, output was up another 50 percent from 1932. 13
The gold reserves of the central banks and related government funds jumped from about forty million tons in 1929 ($10 billion at $20.67 per ounce) to sixty million tons ($25 billion at $35.00 per ounce) ten years later.54 The growth in monetary gold around the world was so vast that by 1939 there was enough gold in the monetary reserves of the world to replace all ordinary currency 100 percent with gold coin.ss
This was one rare moment when there seemed to be so much gold in existence that nobody knew what to do about it. Only one solution seemed acceptable: send the gold across the oceans to New York, where the United States stood ready to buy everything at $35 an ounce. Consequently, most of this new gold crossed the oceans to New York, along with a lot of old gold. Two contemporary economists, Frank Graham and Charles Whittlesey, described what happened as a "Golden Avalanche." From 1900 to 1913, the rise in monetary gold in the United States had averaged around $70 million at $20.67 ($122 million at $35). From 1934 to 1939, the smallest increase in American gold reserves was $1.1 billion.16 Total U.S. imports of gold from 1934 to 1939 added up to the stupendous sum of $9.6 billion, $3.3 billion more than the greatly expanded production of gold during those years; about 20 percent of this inflow came from France, but, in the pain of the Depression, even India was now exporting gold to the United States.17 When World War II broke out, some $20 billion, or 60 percent of the world's monetary gold, was lodged in the United States compared with a share of only 38 percent in 1929 and 23 percent in 1913.58 This massive hoard weighed more than fifteen thousand tons and was equal to twelve years' worldwide gold production at the time. What a pile it must have been! Atahualpa's chamber, when filled with gold, contained only six tons-and even that was greater than the total annual output of gold in Europe in the early 1500s.
What could explain such a phenomenal migration of gold from the whole world to the United States? The mountain of new production did raise questions about whether the price of gold might actually fall, along with the rest of the world's commodities, in which case the best strategy was to sell as much as possible to the United States at $35 as long as the opportunity persisted. But the more significant motivation was political: these were frightening days in Europe. Hitler was on the march, with Mussolini and the emperor ofJapan rattling their swords by his side. Hitler rejected the provisions of the Treaty of Versailles, sent German troops back into the demilitarized Rhineland in 1935-touching the French border-and mounted a vigorous and undisguised program of rearmament almost immediately after he assumed the leadership of Germany. While most other countries were still floundering in the mess of the Depression, Hitler's heavy spending on arms succeeded in pulling Germany out of the Depression as rapidly as Roosevelt's new policies had promoted recovery in the United States. Italy invaded Abyssinia (now Ethiopia) in 1935. The Nazis invaded Austria in 1938 and Czechoslovakia in early 1939; Hitler made off with their gold reserves as soon as his troops entered Vienna and Prague. Meanwhile, the Communist system was thriving in Russia, where output and employment kept rising all during the 1930s.
In this alarming environment, shipping capital across the Atlantic to America seemed to make good sense, especially in the forn-i of gold. The United States, alone in the world, stood ready to buy gold in unlimited amounts at the fixed price of $35.00. Other countries had either stopped buying gold or paid a varying price depending upon the exchange rate of their currencies against the dollar. The dollar/gold relationship was like a fixed star in the heavens to which all other stars and constellations were irresistibly attracted.
But the strangest thing of all was that the United States absorbed those billions of dollars' worth of gold without any sign of some natural force to throw the process in reverse. What had happened to David Hume's authoritative observation back in 1752 that "It is impossible to heap up money, more than any other fluid, beyond its proper level"? (See p. 160.) None of the necessary steps to fulfill Hume's prediction occurred. The bank deposits received by those who exported gold to the United States sat idle or were invested at interest rates of less than 1 percent per annum. It was no time for taking risks. The banks whose reserves were swelled by the golden imports felt the same way: nothing in those days was as beautiful to behold as a nice, fat pile of cash. In short, money continued to heap up in America far beyond its proper level just to sit quietly until the storms had blown over. The process came to be known as a "liquidity trap." The accumulations of cash would be put to use only later when the pressures of wartime spending demanded it.
And so the great Victorian gold standard died an ugly, painful, and protracted death, a process that reached all the way back to the prohibitions on convertibility that were put in place after the outbreak of World War I. The old structure was never completely revived after 1918. The remarkable aspect of the story is that so many people believed they could revive that system in a world that the war had altered beyond recognition.
It is easy to understand the nostalgia for the prewar world that encouraged the struggle to return to gold. It is easy to understand the desire for a system whose simplicity and elegance was unmatched in the history of money. It is easy to understand the fascination with gold-a fascination that had never wavered from the times of Moses and Jason and Croesus and Pizarro right up to the times of Montagu Norman.
But it is not so easy to understand that men could make such mighty decisions on the basis of obsolete visions rather than objective analysis, with their minds shut tight against consideration of any other solution to the problem at hand.59 It is most difficult to understand how so few seemed to learn-until it was too late-the lessons provided by Britain's example of how the simple decision could lead to unparalleled economic agony. The notion that gold would make everything come out all right was a notion that was upside down: gold would make everything come out all right only when everything was all right in the first place. That was the real meaning behind Disraeli's assertion in 1895 that Britain's gold standard was the consequence, rather than the cause, of her commercial prosperity.
As so often happens, the errors became increasingly clear after the fact. P. J. Grigg, who was Churchill's principal private secretary, has related that "Winston has almost come to believe [in his later years] that the decision to go back on gold was the greatest blunder of his life. 1101 This was a striking judgment on Churchill's part in view of the nightmare of his key role as First Lord of the Admiralty in the disaster at Gallipoli in 1915.61
What about Norman himself? In correspondence with Norman in 1944, Russell Leffingwell had observed, "How we labored together, you and Ben [Strong], my partners and I, to rebuild the world after the last war-and look at the damned thing now! "*62 Norman agreed: "As I look back, it now seems that, with all the thought and work and good intentions which we provided, we achieved absolutely nothing.... By and large nothing that I did, and very little that old Ben did ... produced any good effect."63