Economics and The Public Welfare

Chapter 33

The Tragic Year—1931

Climax of Unsound Tendencies. The year 1931 brought to a climax all the unsound tendencies which we have described in preceding chapters. The carelessly created and very excessive fabric of international debt was tested, and debtor countries found themselves with too great an excess of quick liabilities over their quick assets. The strangling effects of the old trade barriers, our own tariffs of 1921 and 1922, and the numerous tariffs erected around the small states of Eastern and Southern Europe, were greatly intensified by our tariff of 1930 and the rapidly growing trade barriers throughout the world which followed. Countries under pressure to pay had increasing obstacles thrown in their way as they sought to pay by shipping out goods.

Failure of Coöperation: London, Paris, New York. Finally, new adverse factors of an unprecedented sort entered the picture. In all past crises, we had been able to count on the effective coöperation of New York, London, and Paris. These great centers had always aided one another when necessary—at a stiff rate of interest—in crises. Certainly it was taken for granted that they would not interfere with one another in their efforts to aid critical situations in weaker countries. This coöperation failed in 1931, except that New York and Paris did help London when the pressure on England came.

Failure of Coöperation in Wall Street, and Between Government and Finance. We had, moreover, in all previous crises been able to count upon effective coöperation within the financial district of New York itself. In 1931 this failed. Previous crises, moreover, had shown excellent teamwork as between Government and finance. Washington and Wall Street in past crises had worked well together, and if Washington felt that there was housecleaning to do, the house-cleaning was deferred until the acute crisis was over. The latter part of 1931, however, saw a new and ominous political factor in the United States. The Congress which assembled on December 4 of 1931 was an angry Congress, grimly determined to investigate and to punish the banking community, which it blamed for the disaster.

Belated Realization of Fiscal Deficit Brings Stock Market Break in Late April, 1931. The year 1931 started out with some improvement in financial sentiment. The stock market, after its selling climax of December 17, 1930, had staged a rally which carried on with great vigor till February 24, 1931. The market sagged after that, but did not have a violent downward movement until the last eight days of April, 1931. Then came a development which ought not to have caught the market by surprise, but which did, namely: the announcement by the Bureau of Internal Revenue of a startling decline in the March 15 tax revenues of the United States Government, and of a heavy Government deficit. With the appearance on the news ticker of the figures showing the deficit, selling began, and the next few days showed convulsive downward movements. The Dow-Jones Industrials dropped from a high of 164.06 on April 21 to a low of 141.78 on April 29.

The revenues of the United States Government for the calendar year, 1930, from individual and corporate income taxes were based, of course, upon the extraordinary earnings of 1929, and despite the heavy losses in the crash of 1929 these were very large. For the fiscal year ending June 30, 1930, revenues stood above the fiscal year ending June 30, 1929, by $140,000,000; but the fiscal year ending June 30, 1931, showed a drop of $860,000,000. Public debt retirement had continued in 1930, the gross debt standing at $16,185,000,000 on June 30, 1930, as against $16,931,000,000 on June 30, 1929. By June 30, 1931, the public debt had risen again to $16,801,000,000, and it moved upward for the rest of the year. The Treasury itself apparently had been living in an unreal world. Despite the steady decline in business which 1930 showed, with the inevitable decline in future revenues which this must mean, it took the actual figures of March 15 tax collections in 1931 to bring home the fiscal realities.

Parenthetically it may be observed that this has important implications with respect to the general policy of putting income taxes on a pay-as-you-go basis. If the Treasury had been harder pressed in 1930 than it was, we might have had a general clarification of the financial situation sooner, with less disastrous consequences.

Boden-Kredit-Anstalt in Austria Insolvent. But the main troubles of 1931 came to a head in Europe and centered in the position of a bank which had been weak and, for that matter, hopelessly involved in the first half of 1929, namely, the Boden-Kredit-Anstalt, with headquarters in Vienna and with branches throughout the succession states of the old Austro-Hungarian Empire.1

On October 7 of 1929, the weakness of the Boden-Kredit-Anstalt was publicly recognized in a merger of that institution with the older, much stronger Oesterreichische-Credit-Anstalt, a merger which had been announced late the Sunday night preceding. New capital was provided by an international syndicate which included J. P. Morgan and Company, the English house of Schroeder, and the Belgian Solvay group. The syndicate was headed by Rothschild of Vienna. The Austrian Government guaranteed certain of the investments of the Boden-Kredit-Anstalt, and the supposition was that this weak spot had been sufficiently strengthened.

Inadequately Refinanced in Merger with Credit-Anstalt. In fact, however, the big merged institution was still insolvent. The job had been done inadequately. But even those who thought that inadequate capital had been provided were convinced that the Austrian Government and the Austrian National Bank would see the institution through. The Austrian situation remained quiet through 1930. Indeed, in the week ending July 19, 1930, the Austrian Government floated a loan totaling approximately $62,000,000 face value, to which subscriptions were made in Italy, Austria, Switzerland, Great Britain, Holland, and the United States, with the Bank of International Settlements as trustee for the loan.

Austro-German Customs Union, March 1931. This weakened Austrian bank might well have been carried through, however, with gradual improvement, with the credit of the Austrian Government and of the Austrian National Bank behind it, but for a very adverse political development. Hard pressed for foreign commerce, with trade barriers and tariffs mounting in the world, and with its natural markets in Hungary, Czechoslovakia, and the Balkans increasingly narrowed by such barriers, Austria turned to Germany. On March 21, 1931, the announcement was made that Germany and Austria had agreed to come into a customs union together, a Zollverein under which Austrian goods would have free access to the German market and German goods would have free access to Austrian markets, with the same tariff structure as against other countries for both of them. This move on the part of both Germany and Austria was primarily an economic move. Bruening was Chancellor of Germany, and his purposes were peaceful purposes. Doubtless he looked upon the measure as one which would strengthen his political position in Germany and make it easier for him to carry through. But the economic advantages both to Germany and Austria were real. Each had more elbow room. Each could immediately give employment to people who would otherwise be idle, in producing goods for the other country to consume.2

Frightens and Angers France. The reaction in France to this German-Austrian move was very adverse. To France, it was a violation of the Treaty of Versailles. To France, it was a political move—not a Zollverein but an Anschluss, namely, an annexation. Austria was being annexed by Germany. Germany was extending her political boundaries. Germany was strengthening herself in a political and in a military way, gaining new soldiers and new resources for war.

France was the strongest financial power in Europe at that time. We have seen, with the financial reforms of France in 1926 under Poincaré, how the tide had turned in France. Capital, which had been flowing out of France, had returned, and France had become a magnet for the world’s gold. The Bank of France had enormous gold holdings and, in addition, enormous holdings in foreign exchange. London was heavily in debt to France on short account. The United States was heavily in debt to France on short account.

France had immense financial power. That in this situation France should have turned from economic coöperation to political fears was an ominous thing.

Run on Credit-Anstalt, May 12, 1931. On May 12 of 1931, there came an unexpected run on the Oesterreichische-Credit-Anstalt, and rumors of impending great disaster in Continental Europe poured in on the great banks of New York.3

It was believed in New York and London that French bankers, instead of aiding the Austrian situation, were pulling funds out of Austria and, in particular, pulling funds out of the Credit-Anstalt—that the run, in fact, had begun through French withdrawals of funds from Vienna. The effort was made, none the les% to bring about a consortium of American, British, and French banks which would save the Austrian situation. Adequate, prompt lending of a small sum as a joint act of these three great money markets would have stopped the run. An amount of $25,000,000 would probably have sufficed; $50,000,000 would certainly have sufficed. New York and London alone could have done it, had there been unity. The Bank of England was eager to do it, but division appeared. In New York a number of the great banks were quite ready and anxious to take part in a credit to Austria if all would go along. But as several important banks held back, all held back. Finally the Bank of England acted alone, but inadequately and unsuccessfully.

Inadequate Help from Bank for International Settlements. The Austrian Government did what it could. It advanced funds to the Credit-Anstalt. Rothschild of Vienna made another effort, but where $25,000,000 was needed, provided only $3,300,000. On May 14, 1931, the Bank for International Settlements offered aid in the form of 100,000,000 schilling credit ($14,000,000), of which 40,000,000 schilling was underwritten by eleven central banks: the Federal Reserve Bank of New York, the central banks of France, England, Belgium, Germany, Italy, Switzerland, the Netherlands, Czechoslovakia, Poland, and Greece. This made a great show of international coöperation, with the Bank of France taking part, but the effect was bad when eleven central banks were providing among them only $5,600,000. Creditors grew more frightened, rather than less. If the thing were to be done at all, it should have been done adequately. The first principle of bank loans in a crisis is that if a borrower needs $100,000 to save him, you give him $100,000 or you give him nothing at all. You don’t give him $20,000.

Austria Collapses. The Austrian Government on May 29, 1931, was authorized by the Parliament to guarantee the liabilities of the Credit-Anstalt up to $150,000,000, but the fabric of confidence was shaken by the delay, by the attitude of France, and by the divisions in New York. Panics are not dealt with effectively through delay, through public discussion, and through fighting for position. A loan of $25,000,000 made promptly at the first sign of the panic would probably have stopped it. There came a time when $100,000,000 would not stop it. By the time the Austrian Government on May 29 voted the guarantee of $150,000,000 the credit of the Austrian Government was so shaken that no one cared about the pledge. When, on June 6, 1931, the Bank for International Settlements arranged to give a second 100,000,000 schilling credit to Austria, the Austrian financial disaster was very little helped thereby.

Germany’s Growing Difficulties, 1929-1931. Austria 4 collapsed, and the run on Germany came. June 1, 1931, showed important withdrawals of foreign balances from Germany. Germany had been under increasing pressure since the middle of 1928, when the effects of tight money in New York began to manifest themselves in Europe. We have discussed this in an earlier chapter. Germany had been getting foreign loans in great volume from 1924 into 1928. But interest rates remained very high in Germany despite the foreign loans, and she remained a magnet for available international funds by virtue of her high rates, even after the New York money market stiffened and led to tightening elsewhere. It was harder to get long term money, but short term banking funds continued to go to Germany. The table on page 237 shows in milliards of Reichsmark the changes in Germany’s international debtor and creditor relationships from the end of the year 1926 to July, 1931.

It will be observed that Germany gained only 300,000,000 marks, or $75,000,000, in long term investments between 1928 and 1929. But her short debt, largely in the form of loans by foreign banks to German banks, or of foreign bank loans to German industries on the guaranty of German banks, increased by 2,700,000,000 marks, or $675,000,000.

This was offset to the extent of 1,000,000,000 marks or $250,000,000 by German short term investments abroad, much of which took the form of deposits or short term, high-grade paper in foreign money markets, so that the net growth of her short debt from the end of 1928 to 1929 was $425,000,000. The net short debt of Germany at the end of 1929 was $1,550,000,000. This was not an impossible short term debt for a great country to owe to foreign countries, but it did create a precarious position in the event of a concerted move by foreign countries to withdraw their funds.

Germany had also an increase in the schedule of reparations payments under the Dawes Plan from 1,750,000,000 marks ($437,500,000) in the fiscal year 1927-1928, to 2,500,000,000 marks ($625,000,000) in the fiscal year 1928-1929, which very greatly increased the pressure.

Estimated Movements in Germany’s International Capital Position † (In milliards of reichsmark)
Situation at end of	1926	1927	1928	1929	1930	July, 1931
Foreign investments in Germany:
Short	4.1	6.6	9.0	11.7	10.3	8.0
Long	4.1	5.4	7.0	7.3	9.2	9.0
Other investments*	3.5	4.5	5.5	6.0	6.0	6.0
Total	11.7	16.5	21.5	25.0	25.5	23.0
German investments abroad:
Short	3.6	3.9	4.5	5.5	5.3	3.5
Long	4.5	4.5	4.5	4.5	4.4	5.0
Total	8.1	8.4	9.0	10.0	9.7	8.5

† This table is an abridgement of a table which appears in the Chase Economic Bulletin of Oct. 8, 1931, p. 19, drawn from the Annexes of the Report of the Basle Committee, the first Standstill Committee, which was drafted by Sir Walter T. Layton. An account of this committee is given in the text infra. The figure of 8,000,000,000 marks for the short term foreign debt of Germany in July, 1931, reached by the Basle Committee, was subsequently added to by a very substantial amount through an investigation made under the authority of the German Government. Sitting with the second Standstill Committee in Berlin in the winter of 1931-1932, the present writer, Secretary of the Committee, conducted an investigation of the basis for the additional figures. His conclusion, as set forth in the report of the second Standstill Committee, issued in Berlin on Jan. 23, 1932, and published in full in the Commercial & Financial Chronicle, Jan. 30, 1932, p. 764, was that the methods made use of were incorrect and that figures of the Basle Committee in their report of August, 1931, were essentially right. Making this investigation, the author had the benefit of full disclosure by the authorities of the Reichsbank and the aid of able German economists. See Report of the Foreign Creditors’ Standstill Committee, Berlin, Jan. 23, 1932, pp. 9 and 10.

* Includes foreign purchases of German shares and obligations in marks, foreign purchases of real estate in Germany, foreign factories constructed in Germany, and other miscellaneous items.

Germany met the pressure by a reversal of her foreign trade position, turning from an importing to an exporting country around the middle of 1929, and had a heavy excess of exports over imports in the period that followed. Had her creditors shown forbearance and had the world’s market remained reasonably open to her goods, she could in time have readjusted her position without collapse.

Forbearance was shown through 1929 and 1930, though withdrawals of funds occurred. The Germans themselves put some short term money out of Germany, as the table above shows. Between the end of 1928 and the end of 1929 they increased their short term holdings abroad by 1,000,000,000 marks or $250,000,000, though this was very much more than offset by increased foreign short term credits to Germany.

In 1930, however, Germany was paying down her foreign short term obligations at a good rate. The figure dropped from 11,700,000,000 marks ($2,925,000,000) to 10,300,000,000 marks ($2,575,000,000) at the end of 1930, while there was a modest return of short term German funds held abroad of some 200,000,000 marks ($50,000,000) in that year.

Germany Vulnerable When Run Came, June 1, 1931. But these payments lessened Germany’s liquidity, and when the foreign run on Germany began around the first of June of 1931, she was very vulnerable. The assets of the German banks, though generally good, were slow. The volume of internationally valid cash was limited. Between the end of 1930 and the end of July, 1931, Germany paid another 2,300,000,000 marks ($575,000,000) to her foreign creditors, reducing at the same time her holdings of foreign cash from 5,300,000,000 marks ($1,325,000,000) to 3,500,000,000 marks ($875,000,000). Most of this took place between the first of June and the end of July, 1931. In the course of it, pressure was extreme. There was a cruel pressure by German banks upon their own debtor customers. There were many bankruptcies, a terrific growth of unemployment, and a banking crisis of the first magnitude.

Unsuccessful Efforts at International “Rescue Party.” In the beginning of the run on Germany, again the effort at international banking coöperation was made. Again $100,000,000, promptly provided by concerted action of British, American, and French banks, publicly announced and instantly made available, could have stopped the crisis. A month later $500,000,000 would have been insufficient. Again there was failure of adequate and prompt coöperation. Again the political fears of France prevailed over her economic interests. Again there was division among the great New York banks as to the proper policies to pursue. Even when most of the banks of New York reached an agreement that they would not withdraw more funds from Germany for the moment, certain other banks held apart from the agreement and continued to pull funds out.

Then $100,000,000 was provided under the auspices of the Bank for International Settlements, by the Federal Reserve Bank of New York, the Bank of England, the Bank of France, and certain other central banks, in the form of credit to the Reichsbank itself, to give it additional gold reserve. The Germans always felt that there were strings on this money, and that they could not properly make use of it. Certainly German bankers in the winter of 1931-1932 were not counting upon it as an available resource. The Reichsbank subsequently repaid it out of its gold and foreign exchange reserves. The same amount of money, provided as a commercial transaction by French, British, and American money markets as a whole, would have been far more convincing.

Hoover’s Moratorium Proposal, June 20. In the midst of the disorder, on June 20, the country and the world were electrified by an announcement from President Hoover. The Congress was not in session, but the President had been conferring with leaders of the Congress, and by telegram and telephone with a majority of the members of both Houses. He was in a position to assure the country and the world that the Congress would endorse the proposal that he was making, and in this statement he was backed up by leading Democrats, as well as leading Republicans—among the Democrats being Senators Joseph T. Robinson, Carter Glass, and Pat Harrison; and among the Republicans, Senators James E. Watson, William Borah, and Reed Smoot. President Hoover’s proposal was that there should be a year’s moratorium, both on the debts of European governments to the United States Government, and on Germany’s debts on reparations account, the first being conditioned upon the second. The proposal was made on behalf of the United States to the governments of England, France, and other creditors to Germany on reparations account.

France Delays Too Long—Germany Collapses. The effect was electric. The markets rallied. The foreign run on Germany was arrested. Hope returned. But again France held back too long. Most of Germany’s creditors very promptly accepted the proposal. France felt that if she gave up reparations for one year she was giving them up forever. It is, moreover, in the French character and the French tradition that immediate acceptance of a contract proposed by another party is out of the question. There must always be discussion and bargaining. There must always be some show of gaining concessions. France delayed, and France delayed too long. It was not until July 6, 1931, sixteen days after the proposal was made, that France accepted the Hoover moratorium. Meanwhile the panic had been renewed. The pressure on the German banks had increased. The German people, as well as foreign creditors, were engaged in the run on the German banks, and finally, on July 15, 1931, the inability of the German banks to weather the strain was publicly confessed.

Restrictions were made on withdrawals of deposits, and all the great banks but one assumed joint responsibility for one another’s liabilities.

The one great bank left out was the Darmstädter und Nationalbank, sometimes known as the Danatbank, headed by Jakob Goldschmidt.

The German Government, however, sent cables immediately to the banks in New York which had advanced credits to the Danatbank, giving its guarantee to those credits.

Communiqué of Seven Governments, Including United States, July 23. The Government of the United States and other governments made a second effort to meet the German situation. A conference was held in London of seven governments, namely, Belgium, France, Germany, Great Britain, Italy, Japan, and the United States, and these seven Governments in a communiqué of July 23, 1931, said:

Promises Governmental Coöperation to Restore Confidence. “In order to insure maintenance of the financial stability of Germany, which is essential in the interests of the whole world, the Governments represented at the conference are ready to cooperate so far as lies within their power, to restore confidence.

“The Governments . . . recommend . . . for relieving the immediate situation: “First, that the central bank credit of $100,000,000 recently granted to the Reichsbank under the auspices of the Bank for International Settlements, be renewed at maturity for a period of three months.”

Asks Banks to Leave Funds in Germany. “Secondly, that concerted measures should be taken by the financial institutions in the different countries with a view to maintaining the volume of credits they have already extended to Germany.”

Calls for International Committee. “The conference recommended that the Bank for International Settlements should be invited to set up without delay a Committee of representatives nominated by the Governors of the Central Banks interested to inquire into the immediate further credit needs of Germany and to study the possibilities of converting a portion of the short-term credits into long-term credits. . . .

“The conference consider that, if these measures are carried through, they will form a basis for more permanent action to follow.”

Express Confidence in German Credit. The communiqué also stated: “The recent excessive withdrawals of capital from Germany have created an acute financial crisis. These withdrawals have been caused by a lack of confidence, which is not justified by the economic and budgetary situation of the country” (italics mine).

It will be noted that there is indefiniteness in this communiqué, because it does not state whom the “representatives” nominated by the Governors of the central banks should represent. The Government of the United States had no relation with the Bank for International Settlements. The Federal Reserve Bank of New York held no stock in the Bank for International Settlements. Such stock as was held in that bank in New York was held by commercial banks. The Government of the United States had taken no official part either in the Dawes Plan or in the Young Plan, and the Bank for International Settlements was an outgrowth of the Young Plan of 1929.

The Basle Committee—First “Standstill” Agreement. But the Bank for International Settlements and the central banks immediately concerned, including the Federal Reserve Bank of New York, interpreted the invitation as meaning that representatives of the banking creditors of Germany should be appointed. Such a committee was promptly appointed, sat in Basle in August, 1931, with representatives of the German Government and of the German banks, and promptly reached an agreement by which a “standstill” or “Stillhaltung” was created, to last for six months, during which foreign banks would withdraw only very small amounts from Germany, and during which it was hoped the governments would make good their promise to “cooperate so far as lies within their power to restore confidence.” This agreement was generally accepted by Germany’s bank creditors throughout the world, and very especially in the United States, England, France, Holland, and Switzerland.

The committee was an extraordinarily able one, consisting of the following members:

Albert H. Wiggin (Chairman), U. S. A.

Alberto Beneduce, Italy

Dr. R. G. Bindschedler, Switzerland

E. Francqui, Belgium

P. Hofstede de Groot, Netherlands

Walter T. Layton, Great Britain

C. Melchior, Germany

E. Moreau, France

O. Rydbeck, Sweden

T. Tanaka, Japan

Its report, drafted by Sir Walton Layton, is an extraordinarily able document of first-rate historical significance.

Bankers Did Their Part, Governments Did Not. The plan made by the committee was, of course, a standstill, a temporary measure. It could be effective only if the governments kept their promise made in the communique above. The governments did not keep their promise. The bankers did their part and the governments did not do their part.

Hoover-Laval Meeting. October, 1931, saw another development looking toward the permanent rectification of the reparations and interallied debt problem—a cautious move by two of the seven governments which had promised the world in their London communiqué of June 23, 1931, that they were “ready to cooperate so far as lies within their power to restore confidence” and had called upon the banks of the countries to continue their credits to Germany. In October of 1931 Laval, Prime Minister of France, visited President Hoover in the United States and the two of them issued a joint statement which contained the following cautious but significant paragraph:

“In so far as intergovernmental obligations are concerned, we recognize that prior to the expiration of the Hoover year of postponement some agreement regarding them may be necessary covering the period of business depression, as to the terms and conditions of which the two governments make all reservations. The initiative in this matter should be taken at an early date by the European powers principally concerned within the framework of the agreements existing prior to July 1, 1931.”

In this statement President Hoover says in substance to Prime Minister Laval, “Now, Laval, you go home and fix it up with Germany within the Hoover year of postponement, and then come back to me and I will talk business with you.”

It is probable that if Laval on his return to Europe had immediately taken action, some real solution might have been worked out. The second Standstill Committee in Berlin, in December, 1931, and January, 1932, was hoping against hope that prompt action could be taken, that the promises of the governments would be made good, and that, in particular, France could be induced to act so that the air might be cleared regarding reparations and interallied debts, and so that the credits which had been given to Germany could be straightened out in an orderly way. If the governments had acted that winter, Hitler would never have come into power, and we should have saved the democratic regime in Germany.

But governments move slowly and politicians look to the next election. It was not until the Lausanne Conference, June 16 to July 10 of 1932, that France and Germany and other European governments, creditors of Germany on reparations, worked out an adjustment with Germany which practically abolished reparations, contingent on our making big concessions on interallied debts.

By that time President Hoover found himself with a political campaign on his hands, and he did not talk business with the European governments “within the Hoover year of postponement.” The political atmosphere had changed. Public sentiment in the United States had grown bitter with respect to our European debtors, and nothing was done.

In all previous conversations with this man I had found him a calm, dispassionate, well-informed financier with breadth of international vision and a disposition to work well with the bankers of other countries in holding things steady. I had found him critical of narrow nationalistic policies, and had found him disposed to look upon banking transactions between France and Germany as business and financial transactions rather than as political transactions. On this occasion, however, I found myself talking with a frightened French patriot, in whose mind political fears for the future of France transcended all other considerations. It was, he held, not a Zollverein, it was an Anchluss. French bankers could not be expected to join in a rescue party for Austria when they would thereby merely strengthen the great military enemy of France.

• 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.
• 3See my book The Effects of the War on Money, Credit and Banking in France and the United States, published by the Carnegie Endowment for International Peace, Oxford University Press, New York, 1919. For London, see the interesting articles by Mr. J. M. Keynes in the British Economic Journal in late 1914.
• 4O. M. W. Sprague: “Crisis of 1914 in the United States,” American Economic Review, September, 1915; H. G. S. Noble: “The New York Stock Exchange in the Crisis of 1914,” Garden City, N. Y., Country Life Press, 1915. These two papers are classics of permanent value.