55. The meeting had been planned before the crisis began in May. Norman had wanted a meeting of the principal banks for a long time. Strong had been hesitant but changed his mind. The location of the meeting, New York, shows the shift in power toward the United States.
At all costs reduce the price of money. (Moreau 1954, as quoted in Clay 1957, 231)56
Norman hoped to end speculation that the franc would appreciate by having Moreau announce that France would maintain its exchange rate. Instead, the Bank of France lowered its official discount rate to 5 percent. By late summer, open market rates had fallen to 2 percent (Board of Governors of the Federal Reserve System 1943, 656). Norman argued that any British rate increase must come later, after the British economy improved. He feared riots if he raised interest rates at once, but he promised to raise the discount rate a full 1 percent if conditions in industry improved (Clay 1957, 231).
The central bankers’ meeting in New York began on July 2 and continued through the week. To maintain secrecy about decisions, the group met at the summer home of Ogden Mills, undersecretary of the treasury.57 It did not keep minutes, and members of the Board were not informed about the agreements.58 After the meeting, on July 9, the central bankers met with the Board and Treasury officials in Washington but did not discuss details of the agreement.
Strong did not make notes of the New York meeting. Our information comes from Moreau (1954, 367–72) and Clay (1957, 237). The conference considered four problems: discount rates, gold movements, the pound-franc relation, and the worldwide decline in commodity prices. Strong offered to lower the discount rate to 3.5 percent, citing domestic reasons for the action. This pleased the British and Germans but not the French, who favored higher rates in Britain and Germany as a classical response to a weakening currency.59 Strong offered to sell gold to France and Germany at a price equal to the London price and absorb the extra transport cost; Germany and France agreed to buy gold in New York under these conditions.60
56. Moreau published the account in the late 1930s; 6.5 percent was the French long-term interest rate at the time of the Paris meeting.
57. Norman and Schacht traveled to the United States incognito, but their arrival in New York was well known and the subject of much speculation. Mrs. Ogden Mills describes Norman at the meeting. Despite warm July weather, Norman dressed in a large velvet-collared cloak and sat in a fan-back chair placed at the end of the room (CHFRS, March 1, 1954). The Committee on the History of the Federal Reserve, organized at the Brookings Institution in the mid-1950s under the direction of Allan Sproul, interviewed several participants in Federal Reserve policymaking and administration. The unpublished notes are at the Brookings Institution. The principal publication from the project is Chandler’s book on Strong. At the time, Sproul was president of the Federal Reserve Bank of New York.
58. After these meetings, the Open Market Investment Committee met with Norman. Governor Crissinger represented the Federal Reserve Board, but no other members were invited. Wicker (1966, 111), relying on Hamlin’s diary, reports that their exclusion irritated members of the Board and added to their animosity toward Strong. We know most about Miller’s irritation because he testified at length about the 1927 meetings and his own meeting with Schacht before the luncheon. He described the luncheon at the Board as a “social” event (House Committee on Banking and Currency 1928, 216–220). On June 15, in advance of the meeting but after it was scheduled, the Board reviewed the authority of reserve banks to conduct foreign business and the Board’s supervisory role. The secretary was instructed to open and read the sealed agreement with the Bank of England, signed in December 1916. The legal opinion of the Board’s counsel was that the act authorized the reserve banks to enter into such agreements and to lend abroad.
After the meeting, the Federal Reserve banks reduced discount rates and began large-scale purchases of acceptances and government securities, and the Bank of France began forward sales of French francs and purchases of pounds in the Paris market.61 The capital flow reversed. The pound rose to the highest value reached since the war, and gold flowed to London. By year end, cooperation—both Federal Reserve and French action—appeared to have improved the foreign exchange position of the Europeans and encouraged domestic expansion in the United States. Despite Norman’s statements to Moreau in May, Britain maintained the 4.5 percent discount rate unchanged until February 1929. France lowered its discount rate to 4.5 percent in December.
Eichengreen (1992, 213) regards this episode as “an admirable instance of international cooperation.” There is ample evidence in the minutes that international considerations influenced the decisions as to timing and magnitude of the actions and the uniform reduction in discount rates at reserve banks. Although some officials justified their votes by appeals to the beneficial effects on the sale of United States crops abroad and others were influenced by falling commodity prices, the minutes report that
the most important consideration at the meeting was undoubtedly the fact that the differential between the rates in New York and the rates in London was not today sufficient to enable London, and therefore the rest of Europe, to avoid general advances in rates this autumn unless rates here were lowered, and the consequence of such high rates as would result in Europe would be unfavorable to the marketing of our export produce abroad and would have an adverse effect generally on world trade. (OMIC Minutes, Board of Governors File, July 27, 1927)62
59. Goldenweiser’s diary reports on a 1949 letter from Rist that claims the reduction was agreed to in a meeting between Norman and Strong by themselves. Schacht and Rist approved it after the fact. See Wicker 1966, 112.
60. In late June 1927 the London price (in dollars) was $20.64 per fine ounce, above the price in the Netherlands or Switzerland but below the $20.669 in the United States. Strong’s offer lowered the price in New York and absorbed shipping costs (memorandum, Harrison to Strong, Sproul files, December 2, 1927).
61. Kindleberger (1986, 51) reports the total of these transactions as $440 million in May 1928 and almost $600 million in June 1928.
Federal Reserve action improved the short-term problem but did nothing about the long-term problem.63 French and British exchange rates were misaligned relative to gold, the dollar, and each other. The franc had depreciated officially by 80 percent, the pound not at all. After adjusting for price level changes, the franc was undervalued, the pound overvalued. Sooner or later, capital was bound to flow from Britain to France, the United States, and elsewhere.
Cooperation had not resolved the basic problem. Although the governors discussed falling commodity prices at the July meeting, they did not discuss a policy to stabilize price levels and exchange rates. Short-term concerns dominated a long-term solution. A choice had to be made between parity changes and price level changes. Both were ruled out politically. Neither France nor Britain was willing to adjust its exchange rate. Britain was unwilling to deflate further; France and the United States were unwilling to inflate. Temporary United States interest rate reductions, United States loans to Europe, or French decisions to buy gold in New York rather than London, as in 1927, could postpone but not prevent a long-term solution. If governments maintained the misalignment, the only issue was when financial markets would begin to force price level or parity changes.64 The answer, we know, was September 1931, when Britain left the gold standard.
Breakdown
The Board’s annual report for 1928 defended the 1924 and 1927 actions as factors “favoring the redistribution of gold [that] . . . contributed to the maintenance of the gold standard [and] . . . reduced the fluctuations of the exchanges to a range within the gold points” (Board of Governors of the Federal Reserve System, Annual Report, 1928, 16).65 By emphasizing the distribution of gold instead of the exchange rate misalignment, the Board’s statement overemphasized the benefits of short-term activist policies while neglecting the long-term problem. The same mistake was repeated in the 1960s in the efforts to “save” the Bretton Woo
ds system of fixed exchange rates without correcting the misalignment of exchange rates.
62. Goldenweiser’s summary of policy from mid-1927 to 1929, based on his records but written later, repeats this argument but adds that higher rates abroad “would have endangered the maintenance of the gold standard” (Goldenweiser to Miller, Board of Governors File, box 1449, October 30, 1934).
63. The gold flow reversed quickly. In the first six months, the United States received $200 million in gold. From July 27 to December 28, 1927, it sold $193 million. Open market purchases offset the domestic effect of the gold outflow.
64. The problem was repeated in slightly different form in the 1960s with similar outcome—the breakdown of the standard.
65. Board members, governors, and leading members of Congress shifted their views in the 1930s. They blamed Strong’s policy change for subsequent credit expansion, and they blamed the rise in stock prices on the credit expansion. The result, they said, was an inevitable collapse.
The Board was not alone. Many observers at the time saw the maldistribution of gold as the core problem, just as they were to regard the “shortage” of gold as the core problem of Bretton Woods (League of Nations 1932).66
The distribution of monetary gold stocks had changed from prewar values. Table 4.2 shows the principal changes for the United States, Britain, and France. Estimates for the world are imprecise, but greater precision is unlikely to change main conclusions: Britain had a larger relative share in the 1920s than in 1913; France had restored its 1913 share by 1928; the combined United States and French shares rose from 50 to 55 percent in 1929, draining gold from the rest of the world; and the most significant change during the years 1926 to 1931 was the relative and absolute increase in French gold holdings.
The French view of the period 1927 to 1929 claimed that purchases by the Bank of France “tended to establish a better balance in the world’s distribution of gold” (Aftalion 1931, 8). After the de jure stabilization of the franc in June 1928, the Bank of France was no longer permitted to purchase foreign exchange. Foreigners had to pay in gold: “It was hoped, however, that foreign banks of issue, by raising their discount rates, would prevent the flight of their gold to France.” Writing soon after these events, Aftalion recognized the overvaluation of the franc, but he saw the solution as coming principally from an end to British investment abroad, not a change in French policy (8–10).
Despite the gold inflow, French wholesale prices, after declining rapidly in 1926, remained unchanged between the de facto stabilization in December 1926 and March 1929. In the next eighteen months, wholesale prices fell 16 percent, a compound annual rate of 11 percent a year, somewhat faster than the decline in the United States during the same period (League of Nations 1932, 46; Aftalion 1931, 10). Stable or falling prices reflected the combined effect of increased demand for francs by domestic and foreign holders after stabilization and the policy of the Bank of France.67
66. Perhaps one reason for the emphasis on maldistribution in the 1920s is that the stock of monetary gold increased much more than commodity prices. The 1925 commodity price index for the world increased 60 percent from 1913 to 1925; the world monetary gold stock doubled. For the rest of the decade, the commodity price index fell and the monetary gold stock rose. The world’s price index is the wholesale price of commodities from League of Nations (1930, 84). The stock of monetary gold is from Board of Governors of the Federal Reserve System (1943, 544).
The law required the Bank of France to stop purchases of foreign exchange after June 1928. It did not require sales. Between 1928 and 1932, France reduced the share of foreign exchange in central bank reserves from 51 percent to 5 percent, an aggregate sale of more than $1 billion, 9 to 10 percent of the world gold stock. Many other countries reduced foreign exchange reserves in 1931, anticipating or following the British devaluation. France began large-scale sales of foreign exchange for gold in 1929 and continued to sell throughout the period (Nurkse 1944, app. 2, 234–35).68
French policy and French growth redistributed gold from the United States to France in 1928. In the next three years, France and the United States absorbed gold from the rest of the world. The redistribution toward France made the gold standard more deflationary after the French stabilization than before.
The French response to criticism denied the relevance of the quantity theory of money, linking prices to past or current changes in money and gold, and cast doubt on any effect of higher discount rates on price levels. The Bank of France kept its discount rate below the levels in other countries, and the government reduced taxes on sales of foreign securities in the French market to stimulate capital exports (Aftalion (1931, 11–13). But the bank’s sales of foreign exchange dwarfed any effect of these efforts.69
67. The increased demand for francs despite falling interest rates reflected not only stabilization but the rapid growth of the French economy after 1927. Between 1927 and 1929, GDP rose 13 percent and industrial production 17 percent compared with GDP growth of 4 percent in Britain and 7 percent in the United States. French M1 growth was 15 percent, approximately equal to growth of production (data from St. Etienne 1984).
68. Nurkse’s data differ slightly from the data in table 4.2. French sales were usually made in the forward market by selling pounds forward. This policy began in August 1927, possibly reflecting an understanding at the New York meeting in July, to avoid sales in the spot market that were more easily monitored by private speculators and the Bank of England.
The particular crises that ended the interwar gold standard, in the summer and fall of 1931, have been analyzed many times, for example in Eichengreen (1992). The timing of these crises depended on the patterns of lending and borrowing that helped to sustain the system in the late 1920s and the subsequent reduction in lending. In this sense, international cooperation to “rescue” currencies by larger loans from surplus countries could have kept the system viable for a longer time. Without a willingness to permit price levels and exchange rates to adjust, crises seem to be the inevitable, but costly, means of adjusting exchange rates.
Federal Reserve policy of restoring the gold standard and maintaining stable prices failed. The principal fault was not insufficient cooperation but failure to follow the rules.70 The United States and France shared responsibility, but Britain’s (and other countries’) unwillingness to deflate also contributed. When Britain abandoned the gold standard on September 21, 1931, the London Times wrote:
The international economic crisis has played a large part in the temporary abandonment of the gold standard. The responsibility for this belongs to those countries that have hoarded gold on an unprecedented scale. . . . Prohibitive tariffs keep out goods, and unless the creditor nations relend the credits due to them, the debtor nations must pay in gold to the extent of their resources and then default. The gold standard game can only be played according to its well-proven rules. It cannot be played on the new rules practiced since the War by France and the United States. (Quoted in Crabbe 1989, 434)
PRICE STABILITY AND POLICY RULES
Inflation and deflation in 1920–21 heightened interest in the Federal Reserve’s choice of policy objectives. Some economists, influenced by Irving Fisher’s work on the purchasing power of money, favored price level stability as the main goal of Federal Reserve policy. Others supported price stability as an interim solution, pending the return to an international gold standard.
69. Like Strong, Moreau wanted to build his country’s financial center at Britain’s expense. One part of this policy was to shift French reserves into gold until France, like Britain and the United States, held only gold as a reserve. See Chandler 1958, 379–80. There was in addition France’s desire to divide Europe into two spheres of financial influence, one British, one French. See Moreau 1954, 489. Personal relations may also have been a factor. Moreau and Norman did not have a warm or cordial relationship. There is a parallel in the 1960s when France insisted on converting dollar reserves into gold t
o reduce “American hegemony.”
70. For a different view, stressing the absence of international cooperation, see Eichengreen 1992.
The severity of the inflation-deflation cycle, particularly in the heavily agricultural regions, gave popular support and created political pressure for stable prices. Stable money societies, influenced and encouraged by Fisher, campaigned actively for price stability. With the return of price stability during the 1920s, the Federal Reserve received credit for the more stable conditions; this encouraged advocates of a congressional mandate to believe that a stable price level rule was feasible.71
Congress held hearings on legislation setting price stability as the policy goal in 1922–23, 1926–27, and 1928. With the important exception of Benjamin Strong in 1928, all Federal Reserve officials and staff opposed the legislation, and it never became law.72 The extensive hearings go much beyond the reasons for the Federal Reserve’s opposition; Strong, Miller, and others from the Board and the reserve banks explained how monetary policy worked and the reasons for specific policy actions. The testimony showed the deep divisions and confusion within the system about how to conduct monetary policy.
In 1922–23, the Banking Committee considered House Resolution 11788, Irving Fisher’s proposal for a compensated gold dollar. The resolution, offered by Congressman T. Alan Goldsborough of Maryland, would have replaced the fixed price of gold, $20.67 per fine ounce, with a fixed number of grains of gold, the number of grains to be adjusted every two months based on changes in a basket of one hundred wholesale prices. The proposal restricted the maximum adjustment at each two-month period to 1 percent. If the wholesale price index rose, the relative value of gold declined, so the number of grains of gold had to increase to keep the real purchasing power of money constant. Conversely, a decline in the price index required a reduction in the number of grains of gold in a dollar.
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