Another long Cabinet meeting in Berlin ensued that evening. To the surprise of most attending, Schacht was invited and seated next to the chancellor. By a strange quirk of fate, the English and American editions of his book The End of Reparations were to be published in London and New York the very next day. The book was a long assault on reparations, the policy as Schacht described it of “bleeding Germany white” and “destroying Germany’s credit.” One excerpt in particular was heavily quoted in British and American newspapers: “Never has the incapacity of the economic leaders of the capitalist world so glaringly demonstrated as today. . . . A capitalism which cannot feed the workers of the world has no right to exist. The guilt of the capitalist system lies in its alliance with the violent policies of imperialism and militarism. . . . The ruling classes of the world today have as completely failed in political leadership as in economic.” Such criticism from “the head of one of the world’s most powerful capitalist organizations” was somewhat unusual, commented the New York Times.
Speaking with his usual self-assurance, Schacht urged the cabinet to suspend payments to the foreign creditors of Danatbank, forcing them to bear the consequences of their foolhardy and unsound lending practices. The government, believing that this would completely destroy any hope of a rescue from abroad, decided not to take his advice.
The cabinet meeting finished at 2:00 a.m. Later that morning Luther boarded yet another plane, this time for Basel, to make one last desperate plea to the central bankers gathered at the BIS. After being closeted in conference for twelve hours, they emerged to announce that no new credits would be forthcoming. At 11:20 p.m. Basel time, Harrison got through to Norman. The Englishman sounded “tired, disgruntled and discouraged.” The problem was just “too big for the central banks,” he reported. The only solution was for the whole structure of war debts and reparations that had weighed down the world for the last dozen years to be swept away.
On the morning of Monday, July 13, as Luther was setting off for Basel, the Danatbank had failed to open. On the locked doors of all its branches was posted a government decree guaranteeing its deposits. At a press conference, Jacob Goldschmidt revealed that the bank had lost 40 percent, some $240 million, in deposits over the last three months, about half of which were to foreigners. He blamed the run on wild rumors fueled by anti-Semitic agitation in the Nationalist press.
The Reichsbank, hoping that the impact might be contained, kept the rest of the banking system open that day. By lunchtime, branches of every bank in the country were besieged. The leading banks restricted withdrawals to no more than 10 percent of a depositor’s balance. In the Berlin suburbs, savings banks were so overwhelmed that that they closed under heavy police guard. In Hamburg, sporadic riots were blamed on Communist agitators. That evening President Hindenburg proclaimed a two-day bank holiday. The authorities hoped that a short breathing space would allow people to come to their senses. In the event, banks throughout Germany remained closed—except for the most essential business of paying wages and taxes—for another two weeks, during which commercial life in the country was brought to a virtual standstill.
All the banks in Hungary were closed for three days. In Vienna, another of the large banks shut its doors. In Danzig and Riga, in Poland, Yugoslavia, and Czechoslovakia, banks were suspended. German tourists across Europe, even in fashionable sophisticated cure resorts like Marienbad and Carlsbad, were stranded when no hotels or shops would accept their marks. The German government issued one decree after another. Despite the massive unemployment, interest rates were hiked to 15 percent just to keep money in the country. All payments on Germany’s short-term foreign debt were suspended. All foreign exchange had to be turned over to the Reichsbank and all movements of money out of Germany were tightly regulated, the practical equivalent to going off gold.
For the second time in less than eight years, Germany faced economic disaster. Despite the chaos, the country remained surprisingly peaceful, save for a few small riots in Leipzig and Dresden, Düsseldorf and Koblenz. There was an atmosphere of “resigned passivity born of a weary submission to the inevitable,” wrote the New York Times, the consequence of a decade of economic turmoil. The British ambassador, returning after a few weeks’ absence, noted that he was “much struck by the emptiness of the streets and the unnatural silence hanging over the city, and particularly by an atmosphere of extreme tension similar in many respects to that which I observed in Berlin in the critical days immediately preceding the war . . . an almost oriental lethargy and fatalism.”
“In such circumstances,” he continued, “Dr Schacht’s financial reputation has revived and he has reappeared on the stage . . . there are small but widening circles which feel that Dr. Schacht, if only he could overcome his unpopularity abroad, and especially in the U.S.A. and with Social Democrats at home, might yet be the man to save Germany.” The government did try to induce Schacht to return to power, offering him the position of the banking czar with responsibility for sorting out the whole mess caused by the meltdown. Fearing he was being offered a poisoned chalice, he refused and returned to his country estate to wait upon events.
The collapse of the German banking system in the summer of 1931 sent the economy lurching downward once again. Over the next six months production fell by another 20 percent. By early 1932, the industrial production index reached 60 percent of its 1928 level. Nearly six million men—a third of the labor force—were without work.
In October 1931, the parties of the right collectively staged a rally in the little mountain spa of Bad Harzburg, one of the few places where the wearing of brownshirt Nazi uniforms had not been banned. It was a reunion of everyone who was or had ever been against democracy in Germany. The town was festooned with banners in the old imperial colors. Aged generals and admirals from the previous war turned out, as did two of the sons of the ex-kaiser, the princes Eitel Friedrich and August Wilhelm, rubbing shoulders with an assorted collection of industrialists, politicians, and five thousand goose-stepping paramilitary militia and storm troopers from various factions. The event was kicked off by an invocation for divine guidance by a Lutheran pastor and a Catholic priest. The star of the occasion was Hitler, who hogged the spotlight with his impromptu speeches.
An equally big stir occurred, however, when Schacht, in his first public appearance as an associate of the Nazis, ascended the stage to speak. He accused the government of misleading the country on the amount of foreign debts and gold reserves. As to the economic policies of the opposition, he was obscurely vague, saying only that “the program to be executed by a national government rests on a very few fundamental ideas identical to those of Frederick the Great after the Seven Years War.”
The speech provoked outrage in the Reichstag and within the government. For the ex-president of the Reichsbank to declare publicly that the country was bankrupt—though this was essentially true—was viewed as an act of vindictive irresponsibility and betrayal that could only add to the economic turmoil. That most of the foreign debt had been amassed on Schacht’s watch only added to the anger. There were even calls in parliament and in the press for his prosecution on a charge of high treason. Schacht had long since broken with the left. He had now estranged himself from the democratic center. His only home was with the Nazis. And though the struggle against reparations was now essentially over, the fight for the future of Germany was still to enter its last act.
20. GOLD FETTERS
1931-33
Lo! thy dread empire Chaos! is restored:
Light dies before thy uncreating word;
Thy hand, great Anarch! lets the curtain fall,
And universal darkness buries all.
—ALEXANDER Pope, The Dunciad
ON July 14, Norman returned from Basel to find the crisis now spreading to Britain. That evening Robert Kindersley, a director of the Bank of England and head of the London arm of the great investment house of Lazards, asked to see him in private and told him that Lazards itself was in ser
ious trouble. Ironically enough it had little to do with the crisis ravaging Central and Eastern Europe. In the midtwenties, a rogue trader in the Brussels branch of the bank had made a wild bet on the collapse of the French franc and lost $30 million, almost double the bank’s capital. He had managed to cover up the loss for years with the connivance of several members of the Brussels office, by issuing IOUs on behalf of Lazards to its counterparts. The extent of the problem had only recently come to light when these obligations were finally presented. When confronted with the evidence, the trader in question, a Czech, confessed, then suddenly pulled out a gun in the office and shot himself. Fearing that the failure of a merchant bank of Lazards’ standing would set off a panic in the City, the Bank of England agreed to bail it out. The following week two other British merchant banks, Kleinworts and Schroders, informed Norman that they, too, were in trouble. Unable to prop up everyone, the Bank arranged for them to be rescued by loans from the commercial banks.
Meanwhile, on the heels of the closure of banks in Germany, a “blizzard” swept through the world’s financial system. A bank holiday was imposed in Hungary, major financial institutions failed in Romania, Latvia, and Poland. In Cairo and Alexandria, a run began on the German-owned Deustche Orientbank and police had to be called in to protect the management. Istanbul saw runs on the local branches of the Deutsche Bank, and the Banque Turque pour le Commerce et l’Industrie was closed.
The world economic crisis had already engulfed large tracts of South America—Bolivia had defaulted in January and Peru in March. In the last two weeks of July, the contagion extended to other Latin countries. On July 16, the government of Chile suspended payments on its foreign debt. Five days later, it fell and the head of the central bank took over as premier. He lasted barely three days. Over the next twenty-four hours, three different premiers were sworn in, until, fed up with the turmoil, the military took over. On July 25, the Mexican government announced that gold was no longer legal tender and that instead it was shifting to silver. The currency dropped 36 percent and after days of confusion a leading bank, the Credito Español de Mexico, was forced to close its doors.
As the world financial system ground to halt, the City of London, with tentacles that stretched into every corner of the globe, found itself especially vulnerable. On July 13, as the German crisis reached its denouement, the Macmillan Committee on the workings of the British banking system issued its report. Considering all that was going on in Europe, the press paid little attention to it. Nevertheless, hidden in the report was a set of figures that shook the City.
During London’s heyday as a financial center, British industry and British banking had complemented each other. The large export surpluses generated by what was then “the workshop of the world” had provided the funds to finance Britain’s long-term global investments and underpinned London’s status as banker to the world. After the war and the return to the gold standard, Britain’s manufacturing capacity had stagnated. Throughout the 1920s, however, London, determined to maintain its primacy in global finance, continued to lend $500 million a year to foreign governments and companies. But because Britain was unable to generate the same export surpluses as before the war, the City had to finance its long-term loans by relying more and more on short-term deposits. While everyone was dimly aware of this growing mismatch between liabilities and assets, no one had any idea of its magnitude.
The Macmillan Report now revealed that the City’s short-term liabilities to foreigners came close to $2 billion. This was viewed as a shocking number even though it eventually turned out to be a gross underestimate—the true figure was closer to $3 billion.
Furthermore, after the imposition of German exchange controls, a good percentage of the loans made with these deposits were now frozen—British banks had an estimated $500 million tied up in Germany and several hundred million more in Central Europe and Latin America. Suddenly, confronted with the previously unthinkable prospect that London houses, weighed down by bad loans, might fail to meet their obligations, investors around the world started withdrawing funds from the City.
In the last two weeks of July, the Bank of England lost $250 million—almost half its gold reserves. It reacted by raising interest rates modestly from 2.5 percent to 4.25 percent in the hopes of inducing capital not to desert sterling. Norman resisted further hikes, fearing that they would only create more unemployment and by intensifying the domestic depression, might even reinforce the speculative attack on the pound. Since he did not know what else to do, he acted as if the crisis were a temporary bout of nerves and arranged to borrow $250 million from the New York Fed and from the Banque de France to tide the Bank of England through.
Norman had now been dealing with one emergency after another for ten weeks and the “steady drip of the unseen pressure” was beginning to tell on his fragile constitution. He was easily distraught, changed his mind frequently, and at times seemed paralyzed by indecision—bouts of “nervous dyspepsia,” as one of his fellow directors described it. As the prospect of a break from gold loomed, he would portray the consequences in apocalyptic terms—an evaporation of confidence in money such as had occurred during the German hyperinflation, a collapse in currency values, spiraling prices, food shortages, strikes, rationing, and riots. So exaggerated and gloomy was the portrait he painted that Russell Leffingwell, a partner in the House of Morgan, where he was usually treated with enormous deference, finally complained, “Can’t he be persuaded to quit his panicky talk?”
Finally, on Wednesday, July 29, Norman left work early, noting meticulously in his diary, “Feeling queer.” That evening he collapsed and was confined to his house under doctors’ orders to take a complete rest. His colleagues at the Bank, fearing that his erratic moods and impaired judgment would only complicate their efforts to deal with the impending crisis, urged him to go abroad to recuperate. Jack Morgan, possibly prompted by one of the Bank directors, even generously offered his yacht, the Corsair IV, with its crew of fifty. Instead, on August 15, Norman set sail for Canada aboard the Duchess of York.
On July 31, as Parliament rose for its summer recess and politicians and bankers left London for the country, yet another official committee—the May Committee—submitted its report. As the Depression in Britain had deepened, the budget had slipped into deficit and was running around $600 million, 2.5 percent of GDP—a modest gap in the circumstances. The May Committee formed to consider economy measures, exaggerated the size and significance of the deficit out of a combination, in the words of historian A. J. P. Taylor, of “prejudice, ignorance, and panic,” which, in the middle of a run on sterling, created only even more alarm. The May Committee proposed that the government seek to reverse the budgetary slide by cutting its expenditures by $500 million—including a 20 percent reduction in unemployment benefits—and raise an extra $100 million from higher taxes. In the light of what we now know about the way the economy works, it was completely absurd for the committee to propose that the solution to Britain’s economic problems, with 2.5 million men out of work, production down by 20 percent, and prices falling at a rate of 7 percent a year, was to cut unemployment benefits and raise taxes. But at the time, the prevailing orthodoxy held that budget deficits were always bad, even in a depression. Maynard Keynes called the May report “the most foolish document I have ever had the misfortune to read.”
The committee’s recommendations split the cabinet. The majority, led by the prime minister, Ramsay MacDonald, and the chancellor, Philip Snowden, though all fervent and committed Socialists, were wedded to the belief that the budget must be balanced, no matter that Britain was in depression.
Meanwhile, the $250 million loan from the New York Fed and the Banque de France had already been used up—the Bank of England had now paid out a total of $500 million in gold and still the drain continued. Bank officials, taken aback by the immensity of the outflow but convinced that raising interest rates was not the answer, could only propose more borrowing—this time not by the Ba
nk itself, whose credit lines were running out, but by the government. At the beginning of August, the government requested that the Bank put out informal feelers to ascertain the conditions that American bankers might attach to such a loan. The New York Fed, itself precluded by statute from lending directly to foreign governments, passed the inquiry on to J. P. Morgan & Co.
Bankers confronted with a country in need of money almost instinctively reach for budget cuts, preferably achieved by slashing public expenditure, as the right solution for almost any problem. During the following couple of weeks, as the conditions were being hammered out, the government, the Bank of England, and the House of Morgan threw up an intricate smoke screen around their discussions. Morgans certainly did not want its fingerprints on any evidence that it had imposed “political conditions” on a sovereign British government. Nor did the Labor prime minister want it known, not even within his own cabinet, that he had sought the permission of foreign bankers before acting. The chancellor put together a package of measures cutting $350 million in expenditures, including a 10 percent reduction in the dole, and raising taxes by $300 million and submitted it, through back channels at the Bank of England, for Morgan’s consideration.
By the weekend of August 22, as gold losses mounted, a sense of crisis pervaded London. The king suddenly and mysteriously cut short his three-week holiday at Balmoral to return to Buckingham Palace. The cabinet remained in session over the weekend, the first time since the war. For all the prime minister’s efforts at keeping the negotiations under wrap, the whole country, it seemed, awaited the telegram from New York signaling Morgan’s approval. “It certainly is a tragically comical situation,” wrote Beatrice Webb, wife of Sidney Webb, one of the recalcitrant minority in the cabinet against the budget cuts, “that the financiers who have landed the British people in this gigantic muddle should decide who should bear the burden, The dictatorship of the capitalist with a vengeance!”
Lords of Finance Page 44