Economics and The Public Welfare

Chapter 28

The Effect on Europe of Tight Money in the United States in 1929

New York Speculation Participated in by World in 1929. By 1929 the extravagances of the New York stock market had become the central interest, not only for the whole country, but also for the whole world. In May of 1929 a single Viennese bank was sending orders for $250,000 worth of New York stocks to be purchased for the account of its customers in one day, and this kind of thing had been going on for some time in Vienna. The same thing was happening in various other European cities in May and June, except that money was too tight in Germany and Hungary to permit it.

World’s Investment Funds, Loan Funds, and Gold Turn to New York. The tide of investment funds turned definitely from Europe to the United States, whereas in the preceding years it had been from the United States to Europe. Our stock prices were mounting so rapidly that they were an irresistible magnet for a speculatively inclined world. Orders to buy New York stocks came from Asia and Africa. The high interest rates in New York, moreover, were a magnet for loose funds. Banks in Cairo and banks in Morocco, to say nothing of European banks, were sending funds to New York to be loaned on call at the high rates prevailing.

The tide of gold turned toward the United States again. Our gold monetary stock, which had dropped from $4,323,000,000 in April of 1927 to $3,822,000,000 in June of 1928, rose once more to $4,099,000,000 in October of 1929.

Reversal of Flow of Funds Created Strain for European Debtor Countries. The rapid rise in interest rates in the United States in 1928-1929 and the reversal of the flow of funds between Europe and the United States created a very definite strain in Europe. The lending countries of Europe ceased to be regular lenders to the borrowing countries of Europe, and in some cases withdrew funds previously loaned. The borrowing countries of Europe, which for several years had adjusted their economic life to a large inflow of foreign funds, found themselves suddenly pulled up short, with the necessity of paying rather than borrowing.

A borrowing country is an importing country. It brings in the proceeds of foreign loans primarily in the form of goods, and has a surplus of imports over exports. When a borrowing country begins to repay, the scene shifts. It must develop an excess of exports over imports. A transition of this sort, coming gradually, is easily accomplished and relatively painless. But when it must be made suddenly, it is almost inevitable that there should be a period of depression, during which labor and resources are released from producing goods for the domestic market to producing goods for export, and during which prices are reduced so that the country may more effectively compete in the export trade.

European Lenders Cease to Lend in Europe. The lending countries of Europe in the few years prior to 1929 had been England, the Netherlands, Sweden, and Switzerland, and following 1926, to some extent, France. By 1929 London had very little lending ability. Money had tightened sharply despite efforts made by Britain’s financial leaders to keep rates as low as possible. Money had tightened in the Netherlands, and the Netherlands had been withdrawing funds from other countries, especially Germany. Sweden had ceased to be a ready lender.

Germany’s Special Problem—Big Jump in Reparations Schedule. This sudden change came to Germany at a time when she was under the necessity of increasing her payments under the Dawes Plan from 1,750,000,000 marks per year to 2,500,000,000 marks, a sharp jump in the annuities schedule which might have occasioned difficulties even with a normal international money market. An acutely critical situation rose late in April and at the very beginning of May, 1929. Negotiations had been under way for changing the Dawes Plan. The Young Plan conference was being held in Paris. The creditors under the Dawes Plan were ready to reduce the annuities schedules, but they were insisting on doing away with the safeguards which the Dawes Plan had provided and making the reduced schedules unconditionally payable. Dr. Hjalmar Schacht, representing Germany in this conference, was emphatically opposed to dispensing with the safeguards—and the event, of course, proved that he was right. It appeared that the negotiations would break down. A quiet but very substantial movement of funds out of Germany began, as Germans themselves, remembering the “inflation time,” began to place their funds abroad for safety. Vigorous action by the Reichsbank and the German banks held this situation in hand, and New York and possibly some other foreign money markets lent temporary assistance. With the restoration of confidence which came with the success of the Paris negotiations and the adoption of the Young Plan, German funds went home, and the Reichsbank reserve ratio (which had approached, if it had not gone below, the statutory 40%) rose to 51.5% by June 22.

Dawes Plan and Young Plan. The Young Plan provided for a reduction of the Dawes Plan schedules from 2,500,000,000 marks to approximately 1,600,000,000 marks for the first years, with a rising scale of payments in the following years. But it was not to go into effect until September 1, 1929, so that for the year September 1, 1928, to September 1, 1929, Germany did, in fact, make the full payment of 2,500,000,000 marks.

It was necessary for Germany to reverse radically the whole course of her economic life. She had to reduce long-time construction for domestic purposes and increase production for export. Her people had to consume less and to export more. In part this was accomplished by a reduction in inventory in Germany with a more rapid turnover of goods. But the main change had to come through reduction in consumption, reduction in domestic construction, and the application of a greater proportion of Germany’s economic energies to the export trade. Germany did, in fact, develop an export surplus around the middle of 1929, and in the two years that followed had a very large export surplus.

Hungary. Hungary was in a similar position. She had been borrowing. She had long-run plans. Germany’s plans for development had been largely carried through. Hungary was still in the halfway stage. Her position was difficult.

England’s Difficult Position. The position of London was particularly difficult. The British banks had gone to the limit in an effort to revive British trade by extending bank credit. Where ordinarily they had looked upon 50% of their deposits as a limit for their “advances,” i.e., customer’s loans and overdrafts, and tried to keep the other 50% of their deposits in the form of bills or cash or short loans against highly liquid assets, they had allowed the percentage of advances to rise to over 56%. In addition the drains upon the gold reserve of the Bank of England had reduced the reserve ratio from 55.8% on May 22 to 41.9% on July 10.

New issues in London had not gone well. Pressure on sterling continued. The Bank of England had got some momentary help from our cheap money policy in 1927, but long before the end of 1928 the Bank was under pressure again, and in March, 1929, it raised its rate from 4 1/2% to 5 1/2%. But the pressure on sterling continued. The Bank of France, with its enormous holdings of sterling exchange, remained anxious to get rid of its sterling. It had ceased to buy gold in London, and it did not sell sterling in such a way as to break the sterling rate below the gold export point, but whenever there was any strength in sterling there was French selling. Paris was quietly converting sterling into dollars whenever the sterling rate was strong enough to make this possible.

London was resorting to somewhat dubious devices to prevent the loss of gold. The London Statist of June 22, 1929, says:

“The persistent weakness of sterling exchange on New York has at last led to a substantial shipment of gold from this country to the U. S. A. For some weeks the sterling-dollar rate had hovered at or below the gold export point, yet little gold had left either the London open market or the Bank of England for shipment to New York. For some time it was customary for sterling exchange to make shortlived but effective recoveries whenever offerings of gold on the open market coincided with the departure of a fast boat from this country to New York, and thus, despite an average sterling-dollar rate which kept rather below the gold export point, the Bank of England continued to be able to supplement its gold reserve out of the weekly arrivals of new South African gold. As time went on, however, the weakness of sterling—or rather the strength of dollar 1—became so marked that the cost of bringing about the required recoveries in the rate became presumably excessive.”

London’s manipulation of the sterling dollar rate, just before the departure of a fast steamer for New York, was weak and dubious policy. It was a poor substitute for adequate money rates. It came two years before London abandoned the gold standard. It did not generate confidence in informed circles.

• 1This point will be discussed at length in Chap. 34.