Carroll Quigley - Tragedy and Hope - A History of the World in Our Time

As a result there was no reduction in money in the United States. This money, however, was going increasingly into stock-market speculation rather than into production of real wealth. This can be seen from the following table of indices of average stock prices for both England and the United States in the years indicated:

Industrial Shares Prices

(1924 = 100)

YEAR

UNITED KINGDOM

UNITED STATES

1924

100

100

1925

109

126

1926

115

143

1927

124

169

1928

139

220

1929

139

270

1930

112

200

193I

.87

124

1932

84

66

1933

103

95

1934

125

116

The stock-market boom in the United States was really much more drastic than is indicated by these index numbers, because these are yearly averages, and include sluggish stocks as well as market leaders. The boom began as far back as 1924, as can be seen, and reached its peak in the fall of 1929. By the spring of 1929 it had become a frenzy and was having profound effects on business activity, on domestic and international finance, on the domestic affairs of foreign countries, and on the psychology and modes of life of Americans.

Among the financial results of the stock-market boom were the following: In the United States credit was diverted from production to speculation, and increasing amounts of funds were being drained from the economic system into the stock market, where they circulated around and around, building up the prices of securities. In Germany it became increasingly difficult to borrow from the United States, and the foreign loans, which kept the German financial system and the whole system of reparations and war debts functioning, were shifted from long-term loans to precarious short-term credits. The results of this have been examined in the chapter on reparations. In other countries, funds tended to flow to the United States where they could expect to roll up extraordinary earnings in capital gains in a relatively short time. This was especially true of funds from Britain where the stock-market boom ceased after the end of 1928. By that time the fundamentally unsound economic conditions were beginning to break through the facade. The decline in foreign loans by both London and New York began to be noticeable by the last half of 1928 and made it evident that the chief support of the facade was vanishing. But the continued rise of security prices in New York continued to draw money from the rest of the world and from the productive and consumptive systems of the United States itself.

Early in 1929, the board of governors of the Federal Reserve System became alarmed at the stock-market speculation, especially at its draining credit from industrial production. To curtail this, in April 1929, the Federal Reserve authorities called upon the member banks to reduce their loans on stock-exchange collateral. At the same time, it engaged in open-market operations which reduced its holdings of bankers’ acceptances from about $300 million to about $150 million. The sterilization of gold was made more drastic. It was hoped in this way to reduce the amount of credit available for speculation. Instead, the available credit went more and more to speculation and decreasingly to productive business. Call money rates in New York which had reached 7 percent at the end of 1928 were at 13 percent by June 1929. In that month, the election of a Labour government in England so alarmed British capital that large amounts flowed to the United States and contributed further to the speculative frenzy. In August, the Federal Reserve discount rate was raised to 6 percent. By this time it was becoming evident that the prices of stocks were far above any value based on earning power and that this earning power was beginning to decline because of the weakening of industrial activity. At this critical moment, on September 26, 1929, a minor financial panic in London (the Hatry Case) caused the Bank of England to raise its bank rate from 4% percent to 6Y 2 percent. This was enough. British funds began to leave Wall Street, and the overinflated market commenced to sag. By the middle of October, the fall had become a panic. In the week of October 21st on the Stock Exchange and the Curb Exchange in New York, total stocks sold averaged over 9 million a day, and on Thursday, October 24th, almost 19% million shares changed hands. The shrinkage in values was measured by several billion dollars a day. Some stocks fell by 100 or even 140 points in a day. Auburn fell 210 points, General Electric 76 points, and U.S. Steel 26 points in 4% days. By November 6th these three stocks had fallen respectively 55, 78, and 28 points more. It was a financial disaster of unparalleled magnitude.

The stock-market crash reduced the volume of foreign lending from the United States to Europe, and these two events together tore away the facade which until then had concealed the fundamental maladjustments between production and consumption, between debts and ability to pay, between creditors and willingness to receive goods, between the theories of 1914 and the practices of 1928. Not only were these maladjustments revealed butthey began to be readjusted with a severity of degree and speed made all the worse by the fact that the adjustments had been so long delayed. Production began to fall to the level of consumption, creating idle men, idle factories, idle money, and idle resources. Debtors were called to account and found deficient. Creditors who had refused repayment now sought it, but in vain. All values of real wealth shrank drastically.

THE CRISIS OF 1931

It was this shrinkage of values which carried the economic crisis into the stage of financial and banking crisis and beyond these to the stage of political crisis. As values declined, production fell rapidly; banks found it increasingly difficult to meet the demands upon their reserves; these demands increased with the decline in confidence; governments found that their tax receipts fell so rapidly that budgets became unbalanced in spite of every effort to prevent it.

The financial and banking crisis began in central Europe early in 1931, reached London by the end of that year, spread to the United States and France in 1932, bringing the United States to the acute stage in 1933, and France in 1934.

The acute stage began early in 1931 in central Europe where the deflationary crisis was producing drastic results. Unable to balance its budget or obtain adequate foreign loans, Germany was unable to meet her reparation obligations. At this critical moment, as we have seen, the largest bank in Austria collapsed because of its inability to liquidate its assets at sufficiently high prices and with enough speed to meet the claims being presented to it. The Austrian debacle soon spread the banking panic to Germany. The Hoover Moratorium on reparations relieved the pressure on Germany in the middle of 1931, but not enough to permit any real financial recovery. Millions of short-term credits lent from London were tied up in frozen accounts in Germany. As a result, in the summer of 1931, the uneasiness spread to London.

The pound sterling was very vulnerable. There were five principal reasons: (1) the pound was overvalued; (2) costs of production in Britain were much more rigid than prices; (3) gold reserves were precariously small; (4) the burden of public debt was too great in a deflationary atmosphere; (5) there were greater liabilities than assets in short-term international holdings in London (about, £ 407 million to £ 153 million). This last fact was revealed by the publication of the Macmillan Report in June 1931, right at the middle of the crisis in central Europe where most of the short-term assets were frozen. The bank rate was raised from 2 1/2 percent to 4 1/2 percent to encourage capital to stay in Britain. £ 130 million in credits was obtained from France and the United States in July and August to fight the depreciation of the pound by throwing more dollars and francs into the market. To restore confidence among the wealthy (who were causing the panic) an effort was made to balance the budget by cutting public expenditures drastically. This, by reducing purchasing power, had injurious effects on business activity and increased unrest among the masses of the people. Mutiny broke out in the British fleet in protest against pay cuts. Various physical and extralegal restrictions were placed on export of gold (such as issuing gold bars of a low purity unacceptable to the Bank of France). The outflow of gold could not be stopped. It amounted to £ 200 million in two months. On September 18th New York and Paris refused further credits to the British Treasury, and three days later the gold standard was suspended. The bank rate still stood at 4 1/2 percent. To many experts the most significant aspect of the event was not that Britain went off gold, but that she did so with the bank rate at 4 1/2 percent. It had always been said in Britain that a 10 percent bank rate would pull gold out of the earth. By 1931, the authorities in Britain saw clearly the futility of trying to stay on gold by raising the bank rate. This indicates how conditions had changed. It was realized that the movement of gold was subject to factors which the authorities could not control more than it was under the influence of factors they could control. It also shows—a hopeful sign—that the authorities after twelve years were beginning to realize that conditions had changed. For the first time, people began to realize that the two problems—domestic prosperity and stable exchanges—were quite separate problems and that the old orthodox practice of sacrificing the former to the latter must end. From this point on, one country after another began to seek domestic prosperity by managed prices and stable exchanges by exchange control. That is, the link between the two (the gold standard) was broken, and one problem was made into two.