The Deluge

by Adam Tooze

  The cause of this social and economic dislocation, in the United States as across the rest of the world, was not subversion or moral decrepitude, but the financial disequilibrium left by the war. The last Liberty Bond, the Victory Loan, was issued in the spring of 1919 in the hope of soaking up excess purchasing power and consolidating the government’s finances. It brought in $4.5 billion. As during the war, however, these funds came in large part not out of savings but from bank credits, which only served to stoke inflationary pressure. In the course of 1919 the volume of notes in circulation surged by 20 per cent. Faced with such inflation, it was only to be expected that workers would organize to protect their standard of living.

  The financial markets also were showing signs of unease. Throughout the autumn the Treasury struggled to refinance $3 billion in short-term certificates.39 The markets were reluctant to commit to long-term loans, because they were expecting a fundamental change in monetary conditions – and they were expecting it soon. By the last weeks of 1919 it was not simply the President and Congress, or the Labour unions and the Attorney General, who were at loggerheads. Tension between the Treasury and the Federal Reserve Board had reached an extraordinary pitch. To attract long-term investors and to cool the markets the New York branch of the Federal Reserve was noisily demanding an increase in interest rates.40 But throughout 1919 as inflation surged and gold drained out of the Fed’s reserves, the Treasury resisted action. Its dilemma was that any large increase in interest rates would devalue the outstanding stock of Liberty Bonds, which carried an interest rate of only 4.25 per cent. To offer higher rates for new loans would drive down the resale value of Liberty Bonds, penalizing those who had committed their savings to the war effort. As Russell Leffingwell, the Assistant Secretary to the Treasury, made clear to the Fed Board on 4 September 1919, if the price of Liberty Bonds fell below 90 cents in the dollar, the administration could find itself facing unmanageable repercussions in Congress and a panic in the bond market. This was the hostage that had been given to fortune by the unprecedentedly wide dispersal of the bonds and the unsustainably low rate of interest at which they had been issued. Never before had the Federal government managed public debt on this scale. Before the war at most a few hundred thousand wealthy investors had held government bonds. Now the assets of millions of ordinary households were at stake. In the second half of 1919, despite its need for new money, the Treasury was forced to spend $900 million massaging the price of the Liberty Loans, by repurchasing outstanding bonds.41

  From the vantage point of Europe, America might appear to be the only unencumbered centre of world finance. The dollar was the sole major international currency that could still boast a solid gold backing. But with inflation making it attractive to turn dollars into gold, by the end of 1919 the ratio of gold reserves to notes in circulation at the New York branch of the Federal Reserve had fallen to 40.2 per cent, within a whisker of the minimum required by law. Faced with an impending crisis, the governors of the New York Federal Reserve voted to suspend reserve requirements for a grace period of ten days. But the full Board of the Federal Reserve refused to permit this drastic step. Governor Strong, the dominant figure at the New York Fed, was outraged. It was the Treasury’s refusal to allow a timely increase in interest rates that had put the New York banks in danger. He would ‘loyally’ carry out the instructions of the Treasury and Fed Board, ‘but after this he would resign rather than continue such a policy’.42

  On 26 November 1919 when the Fed Board met in Washington, Leffingwell replied with an extraordinary personal attack on Strong, accusing him of attempting ‘to punish the Treasury of the United States for not submitting to dictation on the part of the Governor of the Federal Reserve Bank of New York’. Strong, Leffingwell alleged, was ‘conspiring with the British to manipulate the trans-Atlantic gold flow to America’s disadvantage’. Until 15 January 1920 the Treasury needed to borrow $500 million every fortnight. Until then there could be no thought of an increase in interest rates.43 So uncertain was the Treasury of Strong’s loyalty that they had Attorney General Palmer confirm that in the event of unauthorized, unilateral action by the New York bank, they had the power to relieve him of his position.

  It did not come to that. In the long run the Treasury could not afford to continue subsidizing its existing creditors at the expense of new borrowing. On 2 January 1920 the Treasury offered the first batch of 12-month Treasury Certificates at the higher rate of 4.75 per cent. Three weeks later, Leffingwell completely reversed his previous position. The Treasury was now convinced that ‘nothing but a drastic increase on commercial paper to 6% would curtail the situation’. America was ‘dangerously near leaving the gold standard . . .’. Now it was the turn of the New York Fed to object. A sudden increase in interest rates of almost 50 per cent was ‘unjust’. It would convey the impression either that ‘the Federal Reserve board had lost its head or that conditions must be very critical’. It might incite a panic rather than calming the market. But Leffingwell was in a vindictive mood. ‘If a panic in New York should break out, he would be glad of it.’ With Treasury Secretary Carter Glass casting the decisive vote, rates were raised at a stroke to 6 per cent.44 By June the New York discount rate hit 7 per cent. The Fed was barely seven years old. In the rest of the twentieth century it was never again to attempt a contraction of such severity (Fig. 2).

  The deflationary impact was drastic. The abrupt tightening of credit tipped the American economy over a cliff. After continuing to accelerate to an annual inflation rate of 25 per cent in the first half of 1920, in the second half of the year the price level plunged by an annualized rate of 15 per cent. In the entire macroeconomic record of the US, this switchback is completely unique. In the Great Depression deflation was even sharper, but it did not follow a period of rapid inflation. In 1920 as prices fell, industrial output plummeted and unemployment shot up. By January 1921 the National Industrial Conference Board estimated that industrial unemployment topped 20 per cent.

  But it was agriculture that suffered the worst. The terms of trade for American farmers collapsed and were not to recover for the rest of the twentieth century. In the 1890s the American political establishment had been profoundly shaken by a populist agrarian mobilization triggered by a similarly devastating deflation. William Jennings Bryan had seized control of the Democratic Party. If he had won the presidential election of 1896, he had pledged to take America off the gold standard. Wilson’s institutional innovations of 1913 were supposed to have lain those demons to rest. The New Freedom with its combination of tariff reductions – benefiting export-orientated farmers and working-class consumers – and the new managerial competence of the Federal Reserve were supposed to have rebalanced American capitalism in a progressive direction. The switchback of 1919–20 revealed the fragility of those new institutions in the face of the enormous pressures created by the war. Not only was labour in revolt. As cotton prices collapsed, farmers resorted to ‘night riding’, threatening arson against ginneries and warehouses that paid inadequate prices. A new generation of populists organized in the cross-party ‘Farm Bloc’ tarred Wilson’s Fed with responsibility for ‘the crime of 1920’. One of the first actions of the incoming Republican Congress was a Joint Congressional commission of agricultural inquiry, to embarrass the outgoing Democrats.45 Meanwhile, Wilson’s former controller of currency, John Skelton Williams, fanned the storm of agrarian protest by alleging that the mishandling of the crisis and the collapse in farm prices were the work of a Wall Street cabal.46

  Across the South and much of the West, the agrarian crisis fuelled the second coming of the Ku Klux Klan. Feeding off popular discontent across the American heartland and supercharged by a highly incentivized recruitment system, membership in the Klan surged from a few thousand in 1919 to as many as 4 million by 1924 – one in six, the Klan claimed, of the eligible white male population.47 At their peak thousands of inductees were initiated en masse in torch-lit monster rallies. In
northern Florida entire city neighbourhoods were cleared of their black inhabitants. In 1923 Texas, Alabama and Indiana all returned Klan candidates to the Senate. Southern Illinois was convulsed by white on white ‘Klan wars’. Oregon’s state politics were entirely under the spell of the local Grand Goblin. In Oklahoma the Klan’s influence on the state legislature, court system and police force was such that the state governor was forced to resort to martial law.

  In 1920 the dizzying succession of inflation and deflation set the scene for the electoral humiliation of the Democrats. Running for the Republicans, Warren Harding outscored his hapless Democratic opponent by 60 to 34 per cent. In the wake of that defeat the shrunken remnant of the Democratic Party became a vehicle for Klan influence across the country. At the 1924 election convention of the Democratic Party, the notorious ‘Klanbake’, the Klan caucus came close to derailing the party altogether, as they fought to prevent the nomination as a presidential candidate of the Catholic Al Smith, who stood on an anti-lynching platform. It took a record 103 ballots to defeat the Klan’s preferred nominee, none other than William Gibbs McAdoo, Woodrow Wilson’s son-in-law and wartime Treasury Secretary.48

  IV

  Wilson would linger on in Washington until his death in February 1924. But with his departure from the White House, so goes the familiar story, America’s first wave of internationalism had broken. It was followed by an age of isolationism. But this terminology perpetuates contemporary polemics as historical misunderstanding. If, instead, we recognize Wilson for what he was – an exponent of turn-of-the-century high nationalism, bent on asserting America’s exceptional claim to pre-eminence on a global scale – then what is more striking is the continuity between his administration and the Republicans who followed. Speaking in Boston in May 1920, just as the recession set in, Senator Warren G. Harding had coined the phrase that was to define not only his campaign but his presidency: ‘America’s present need is not heroics but healing; not nostrums but normalcy.’ But he went on to add another telling line. What was called for was ‘not submergence in internationality but sustainment of triumphant nationality’.49 Triumphant nationalism is as apt a description of the policies of the Republican administrations in the 1920s as it was of Wilson’s own administration. Triumphant nationalism was not inward-turning or isolationist. It was by definition addressed to an outside world, but it spoke in terms that were unilateral and exceptionalist.

  In light of fierce contemporary struggles over the ethnic make-up of America, anxieties about foreign subversion and mounting unemployment, it was no surprise that already in the autumn of 1920 Congress was actively discussing a ‘genuine 100 percent American immigration law’.50 Within weeks of his inauguration Harding approved a law that cut immigration from 805,228 in 1920 to 309,556 in 1921–2. Immigration from southern and eastern Europe and Asia was reduced to a trickle. In 1924 the cap was further lowered to 150,000 entrants per year. For centuries the New World had stood open to adventurous settlers. The damming up of transatlantic immigration marked the most decisive break between the liberal modernity of the nineteenth century and the increasing centrality of nation-state regulation in the twentieth century.

  A less novel but nonetheless decisive reversal of liberalism occurred in trade policy. Whereas Wilson had sought to establish US leadership on the basis of a low-tariff policy, on 27 May 1921 Harding signed into effect an emergency law, followed within the year by the Fordney-McCumber tariff, which raised rates on average by 60 per cent.51 In the name of non-discrimination the Federal government was authorized to use the threat of punitive tariffs to extract concessions from major trading partners.52 Harding’s successors would single out France for particular pressure. American protectionism was no novelty, of course. But the full implications of Fordney-McCumber become clear when we recall that France not only had a trade deficit with America, but that its government owed $3 billion to the US taxpayer.

  How was America’s assertive nationalism to be reconciled with its pivotal role in the international economy? If inter-Allied debts were to be serviced, if Germany was to pay even a modest amount of reparations, what the world needed was not protectionism but for the US to serve as an engine for global trade. If America wished to avoid this deepening entanglement, the obvious alternative, as Keynes had insisted, was for the net creditors, Britain and America, to forgive the debt, to deleverage. But that ran up against another radically novel feature of the situation. In 1912 the Federal government’s debt stood at just over $1 billion. Seven years later, in 1919, the total debt burden of the Federal government had swollen to $30 billion. This was modest in relation to the size of the US economy. But of that sum, as much as one-third was actually foreign-owed war debt. Inter-governmental debt was not marginal to the US domestic discussion, it was a highly visible feature of the new world created by the war. In August 1919 Wilson’s administration had unilaterally announced to the Entente a two-year moratorium on repayment. Lloyd George’s government repeatedly appealed to Wilson to join Britain in a more expansive policy of debt write-down. But to no avail.

  Meanwhile, over the winter of 1919–20 the fiasco of Wilsonian political economy was having an immediate impact on America’s European debtors. The abrupt 50 per cent increase in the Federal Reserve’s key interest rates delivered a deflationary shock to the entire world economy. After exporting $292 million of gold in 1919 and billions of dollars in credit, in 1920 new foreign credits dried up. Almost $800 million in gold surged back into the US. To compound this deflationary pressure, between 1918 and 1924 the United States ran a surplus of over $12.6 billion on trade account.53 At a moment of intense political crisis, rather than serving as a dynamo of global trade, the Fed and the US Treasury were applying a massive, unilateral squeeze. Though Woodrow Wilson was passing from the scene a broken man, the fact of America’s ascent remained an inescapable reality of the early twentieth century.

  FOUR

  The Search for a New Order

  19

  The Great Deflation

  In the years that followed World War I the red hand of sedition was sighted from Boston to Berlin, from New Zealand to New York. It gripped even Latin America, which was otherwise largely immune to the intense violence of the early twentieth century. In Buenos Aires over New Year 1919, a bitter strike in a metalworking factory sparked the bloody confrontation of the Semana Tragica (7–15 January 1919), which claimed the lives of perhaps as many seven hundred people. Out of the anti-socialist and anti-Semitic agitation that followed there emerged the Liga Patriotica, which was to serve as the seedbed of the twentieth-century Argentinian right.1 Throughout 1919 and 1920, paramilitaries associated with the Liga collaborated with the army and police in breaking strikes and intimidating trade union organizers, defending Argentina against the spectral threat of international revolution. Tens of thousands of leftist suspects were arrested. From the cosmopolitan Argentinian capital the politics of counter-revolution spread south to the very end of the inhabited world.

  In the autumn of 1921 the notorious Tenth Cavalry regiment under the command of Lieutenant Colonel Hector Varela arrived in Patagonia to put down an insurgency amongst farm workers on the gigantic sheep haciendas of the desolate southern tip of the continent. In collaboration with local Welsh landlords and Leaguistas, the Tenth Cavalry in December 1921 murdered no fewer than 1,500 suspected labour activists. In the New Year Colonel Varela returned to Buenos Aires to be feted as a national saviour. Within a year he was gunned down by a German-born anarchist, Kurt Gustav Wilckens. Wilckens, who hailed from Schleswig, had come to Argentina by way of the coal mines of Silesia and Arizona, where he survived a brief but dangerous spell as an IWW organizer. Before Wilckens could receive his sentence, he himself was shot by Perez Milan, a Leaguist zealot, who had been smuggled into his jail by police sympathizers. The vendetta reached its conclusion only in 1925 when Perez Milan was gunned down by a Yugoslav-born fanatic who had been inspired by the Russian godfather o
f Argentinian anarchism, Germán Boris Wladimirovich.

  It is an extraordinary tale. With variations it can be repeated across much of the world in the aftermath of World War I – a sense of a world coming apart, fantasies of conspiratorial communist influence, a pressing state of economic crisis, a wave of strikes and industrial conflict, fuelling drastic rhetorics of class conflict and violence on both sides. The nineteenth century had been haunted by revolution. Now was the moment, it seemed, that revolution had arrived. But outside Russia the far left was everywhere defeated.2 Across the world, as in Argentina and the United States, the resources of the state and the property-owning classes were mobilized to defend established order aggressively. In Italy in 1922, in Bulgaria and Spain in 1923, a new type of authoritarian, paramilitary, anti-communist dictatorship was established. But in most places the violence ebbed away. The new authoritarianism, to which the left soon applied the generic label ‘fascism’, remained confined to the periphery. In most places, as in the United States, the Red Scare, anti-foreign witchhunts, and nightly gatherings under the sign of the burning cross, came in retrospect to seem like a carnivalesque distraction from the real business of restoring normalcy. That depended less on street-fighting and assassination than on addressing the deeper causes of both domestic and international disorder, above all the financial consequences of the war. As the United States demonstrated, this depended on breaking the inflationary wave. But the US role in this regard was not merely exemplary. It was the pivot of the world economy. The deflationary wave driven forward by America from the spring of 1920 was the true key to the ‘world-wide Thermidor’ of the 1920s, the main driver of the restoration of order, both domestically and internationally.3 It is to this day probably the most underrated event in twentieth-century world history.