Economics and The Public Welfare

Chapter 25

The Conference of Governors and the Intensification of Cheap Money, 1927

We have now reviewed the main elements needed to understand the problems which faced the conference of central bank governors in New York in the summer of 1927. We have seen how England had become overexpanded, with a great increase in her quick foreign liabilities, particularly those held by the Bank of France. This was due especially to her policy of expanding bank credit in 1926 while the great strike was on, but due also to her general policy of trying to make money as cheap as possible despite the modest reserve position of the Bank of England. We have seen how the Bank of France had been obliged to buy sterling and other foreign exchange in the de facto stabilization of the franc, because of the hesitance of the French Government to give a definitive new gold par to the franc. This made it impossible for the Bank of France to receive and pay out gold automatically at a fixed rate in Paris against the issuance or retirement of bank notes.

We have seen how the able authorities of the Bank of France had tried to meet this situation by converting their foreign exchange into gold, meeting, however, resistance and protests from the British monetary authorities. England had gone too far in the expansion of bank credit, and the time had already passed when she could have an easy liquidation and readjustment. Her credit, however, was still strong, and she could have eased off such a readjustment by placing long term bonds in the American market to get the gold with which to meet the French requirements, and there was no question of her ability to stop the drain of gold from England by making rates of interest stiff enough.

Conference Called at Instance of Bank of England. But the Bank of England did not wish to pull up. Failing in his efforts to persuade the Bank of France to be content with sterling reserves, and in his efforts to get concerted pressure on the Bank of France from Continental central banks, Governor Norman turned for help to Governor Benjamin Strong of the New York Federal Reserve Bank. Governor Strong invited to New York for a secret conference the Governor of the Reichsbank, Dr. Hjalmar Schacht; the Governor of the Bank of France, who sent instead the able Deputy Governor, Charles Rist, Professor of Economics at the University of Paris; and Governor Norman of the Bank of England. These three, with Governor Strong, made the conference.

Conference Very Secret—Chairman of New York Federal Reserve Bank Excluded. The conference was, indeed, meant to be very secret. Mr. Gates W. McGarrah, Chairman of the Board of Directors and Federal Reserve Agent of the Federal Reserve Bank of New York, had asserted his right to be present at the conference; but Governor Strong refused, and Mr. McGarrah, instead of fighting, left the city. The whereabouts of the members of the conference was kept secret from the banking community of New York.1

Rist and Schacht Refuse to Join in Cheap Money Policy. Governors Strong and Norman tried hard to get the four countries to go along in a concerted policy of easier money. Professor Rist and Dr. Schacht held back. Schacht was alarmed at the extent to which the bank expansion had gone. He had manifested this in the preceding year by reducing his holdings of sterling and increasing his holdings of gold in the Reichsbank. He is reported to have said, “Don’t give me a low rate. Give me a true rate, and then I shall know how to keep my house in order.”

Rist and Schacht Go Home, Norman Remains. The conference of governors broke up without agreement, and Schacht and Rist went home, promising nothing expect to communicate their intentions with respect to the withdrawal of gold from Britain and the United States.

Strong, Norman, and Cris singer Force the Cheap Money Policy Through. Following the departure of Rist and Schacht, Norman and Strong forced through their programme of cheap money in the United States. In Washington Governor Strong and Governor Norman met a rather supine Federal Reserve Board. Governor Crissinger of the Federal Reserve Board was with them and supported them. The able Adolph Miller of the Board fought, but was overridden by Strong and Norman.

President Coolidge’s Attitude. Regarding the attitude of President Coolidge toward this particular episode, it has not been possible to get exact information. But Coolidge had stated in a speech late in the campaign of 1924, “It has been the policy of this Administration to reduce discount rates.” And it had been clearly the policy of the Coolidge Administration to encourage rising stock market prices. We had seen for years the appalling spectacle of the President of the United States and the Secretary of the Treasury, Mr. Mellon, giving out interviews to encourage the stock market whenever prices seemed to flag. For evidence on this point I would refer the reader to Ralph Robey’s brilliant and justly indignant paper on “The Capeadores of Wall Street,” in the Atlantic Monthly of September, 1928.2

Governors of Other Federal Reserve Banks Unfairly Treated. The Governors of the other eleven Federal Reserve banks were called to Washington. They were not dealt with honestly. They were told that the proposed cheap money move was to “help the farmer.” They were not told that the primary purpose of it was to make it unnecessary for England to honor her gold obligations to France, and to make it possible for England to continue an unwarranted degree of cheap money.

Governor Bailey of the Federal Reserve Bank of Kansas City was chosen as the man to inaugurate the policy. He was to take the first conspicuous step, that of lowering his rediscount rate. Governor Bailey was a good bank administrator. He handled the credits given to the member banks in his district with wisdom and discretion. He did not understand central bank policy. He had limited grasp of the basic forces governing the money market, and his grasp of international financial relations was vague. He trusted Governor Strong. Governor Strong had told him that the cheap money policy was for the purpose of helping the farmers, and Governor Bailey in announcing the reduction of his rediscount rate said it was for the purpose of helping the farmers. He said nothing about helping England, because he did not know that the purpose of the move was to help England. Governor Strong had not told him that.

Chronology of 1927 Cheap Money Policy. The chronological steps in the inauguration of the new 1927 policy were the following: (1) the buying rates on acceptances were lowered at the New York Federal Reserve Bank in late July and early August; (2) between July 27 and August 3 the Federal Reserve banks began a sharp increase in their purchases of Government securities, the figure rising from $385,000,000 on July 27 to $704,000,000 on November 16, an increase of $320,000,000; (3) on July 29 the Kansas City Federal Reserve Bank reduced its rate from 4% to 3 1/2%. The St. Louis, Boston, New York, and Cleveland banks followed (August 4 to 6), and then the Dallas, Atlanta, and Richmond banks (August 12 to 16).

Chicago Federal Reserve Bank Coerced. The Chicago Federal Reserve Bank was suspicious and disapproved. The Chicago Federal Reserve Bank was in a better position to know what was really involved in the policy than the Federal Reserve banks of the more remote places. The Governor of the Chicago Federal Reserve Bank had less confidence in Governor Strong than many of the other Governors had. The Chicago Bank refused to reduce its rate. But the Federal Reserve Board at Washington overrode the Chicago Federal Reserve Bank, and by action of the Board, not of the Bank, the Chicago rate was reduced on September 7.

Finally, the Federal Reserve banks at Philadelphia, San Francisco, and Minneapolis reduced their rates (September 8 to 13).

Impossible at Time to Get Official Explanation of Policy. It was impossible, at the time, to get definite official statements from the Federal Reserve authorities (other than Governor Bailey of Kansas City) regarding their policy and regarding their purposes. The most definite statement at the time was that of the Governor of the Federal Reserve Bank of Philadelphia in a speech before the Philadelphia Association of Credit Men on September 21. The official text of this speech appears not to have been published, but the newspaper accounts represented the Governor as indicating that the European situation, coupled with the desire for facilitating American exports, was the ground for the policy.

In this conversation Rist was careful to make no disclosures as to what was going on in the conference. He wanted information and opinions from me. Our conversation was particularly concerned with the great growth of the gold exchange standard (as distinguished from the gold standard) that had taken place in the preceding year; and the accumulation of sterling and dollar exchange instead of gold reserves in the Bank of France, and in other European central banks. Rist asked searching questions regarding the banking situation in the United States, and regarding our security and commodity markets. From other sources I learned more about the conference.

• 1This point will be discussed at length in Chap. 34.
• 2I have not been able to find that this article was ever published. However, the reader will find much of it in two books by Veblen: Imperial Germany and the Industrial Revolution, New York, 1915; and The Nature of Peace and the Terms of Its Perpetuation, New York, 1917.