One Summer: America, 1927 (30 page)

In the last week of November 1923, Germany replaced the valueless reichsmark with a new currency, the rentenmark. Miraculously, the move had the desired effect and inflation sank back to more manageable, less hysterical levels. By a rather extraordinary coincidence, on the very day that the change was effected, Rudolf Havenstein, head of the Reichsbank, collapsed and died. His successor was Hjalmar Schacht. Because Schacht’s arrival was so exquisitely timely, he received all the credit for restoring stability to the German economy and was hailed forevermore as a financial genius.

A second, later consequence of the French seizure of the Ruhr and all the disruption and bitterness that followed was the rise to power of Adolf Hitler. Some historians have maintained that the Nazis could not have risen as they did without the legitimacy Schacht conferred on them and the financial mastery he brought with him. After the Second World War, Schacht was tried at Nuremberg. In his defense, Schacht
claimed that he had been against the persecution of Jews and had never joined the Nazi Party. He believed in stripping Jews of their rights, but not in killing them, which by the standards of the day made him almost an enlightened figure in Germany. He was acquitted and lived on until 1970. He and Norman also got along well. For the meeting on Long Island, they sailed to America together, under assumed names, aboard the
Mauretania
.

The fourth member of the gathering was Charles Rist, a Swiss-born economist and former professor of law at the Sorbonne who was deputy governor of the Banque de France. The governor, Émile Moreau, spoke no English, so sent Rist in his place. Bald and grave, Rist was eminently respectable but very much the outsider at the meeting. He had joined the Banque de France only the previous year, so was not well known to the other three.

Each man naturally brought to the gathering a measure of national mood, self-interest, and prejudice. France was having a terrible year. Its citizens were feeling poor and hard done by; the disappearance of Nungesser and Coli had been a bitter psychological blow. On an official level, the Banque de France was suspicious of Norman, believing that he would sell out the rest of Europe in an instant if it meant preserving London’s status as a global financial center. Britain, for its part, had just emerged from a costly general strike, and was pained and bewildered by its inability to regain its former supremacy in the world. Norman was personally furious with the French for engineering a quiet but insistent run on British gold reserves, and to show his displeasure was for the time being refusing to address any Frenchman in French. Germany was simply exhausted. Not only had it been landed with crippling reparations payments, but it had also been deprived of much of its capacity to earn foreign exchange. The allied powers had seized a good deal of its shipping, for instance. A fact largely forgotten now is that many of the great ocean liners of the twenties were actually German ships under new names. Cunard’s
Berengaria
, a vessel so splendid that Cunard made it its flagship, had originally been the German
Imperator
. The White Star Line’s
Majestic
had been the
Bismarck
. The American
Leviathan
, on
which Commander Byrd and his team were about to sail home, had earlier sailed proudly as the
Vaterland
.

America, in stark contrast with its European cousins, found itself in the unusual position of doing, if anything, too well. Its economy seemed unstoppable. Inflation was zero and had been for four years. Economic growth was averaging 3.3 percent a year. The latest figures from the Treasury Department, released the day before the bankers assembled on Long Island, showed that for the fiscal year just completed the United States had enjoyed a record budget surplus of $630 million and had trimmed $1 billion off the national debt. It simply wasn’t possible for an economy to do better.

In the stock market, people were making fortunes with no apparent effort at all. F. Scott Fitzgerald in
My Lost City
noted in amazement that his barber had retired after making $500,000—nearly four hundred times the average annual wage—on a single timely investment. For many, playing the market became almost an addiction. Warren Harding did so while president. (He wasn’t supposed to.) When he died, he was $180,000 in debt to his broker. For many like Harding, the great attraction was that you didn’t need money to take part. You could buy on margin—purchasing, say, $100 worth of shares for a down payment of $10, with the balance borrowed from your broker, who in turn borrowed from his bank. From the bankers’ point of view, the arrangement could not have been more pleasing. Banks borrowed from the Federal Reserve at 4 or 5 percent and lent it on to brokers at 10 or 12 percent. They were, as one writer put it, “in the position of being handsomely paid simply for existing.”

As long as shares kept rising, the system worked fine, and for much of the 1920s that is exactly what shares did. It was clear to anyone who cared to look, however, that there was little correspondence between the prices of many shares and the values of the companies they supported. While national output (as measured by gross domestic product) rose by 60 percent in the decade, stocks went up by 400 percent. Since most of
these inflated rises had nothing to do with any underlying profits or productivity, all that kept them so giddily buoyant was the willingness of fresh buyers to bid the prices ever higher.

What most small investors didn’t realize was that things were often stacked against them. Many of the most respected business leaders in the country took part in syndicates in which share prices were shamelessly manipulated for the sake of a large, quick gain at the expense of innocent investors. One such, reported by the financial writer John Brooks in his classic
Once in Golconda
, involved such luminaries as Walter J. Chrysler of the Chrysler Corporation; Percy Rockefeller, nephew of John D. Rockefeller; John Jakob Raskob, national chairman of the Democratic Party; and Lizette Sarnoff, wife of David Sarnoff, the head of the Radio Corporation of America (RCA). A broker working for them bought large blocks of RCA stock at selected intervals. This had the effect of driving the price from $90 to $109. The rise attracted other investors. The broker then cashed in the syndicate’s holding and the members shared a profit of nearly $5 million for less than a month’s work. With the syndicate’s money withdrawn, the shares sank back to $87, leaving other, underinformed investors nursing huge losses. There was nothing to be proud of in any of this, but nothing illegal either. Raskob made most of his fortune through such pools. So, too, did Joseph P. Kennedy, father of President John F. Kennedy.

In 1929, Raskob gave an interview to the
Ladies’ Home Journal
that ran under the headline “Everybody Ought to Be Rich” in which he insisted that anyone could get rich by playing the stock market. In fact, he had by then cashed in most of his shares in anticipation of the fall to come. Hypocrisy in the 1920s was not a condition many people recognized.

Borrowing funded not just a booming stock market but all of life. Thanks to a brilliant new financial invention Americans could suddenly have things they had never expected to have—and they could have them right now. It was called the installment plan, and it changed more than the way Americans shopped: it changed the way they thought.

The idea was simplicity itself. Say a radio cost $100. The customer
bought it for $110 by paying $10 down and $10 a month for ten months—and thus had the pleasure of a radio immediately for an additional cost of just $10. The retailer sold the contract to a finance company for $83 which, with the $10 down payment, gave the retailer $93 in hand. At the end of the ten months, the finance company gave the retailer $10 more as a fee for collecting the monthly payments. The upshot is that at the end of the payment period the retailer earned $103, the finance company made $7 on an investment of $83, and the customer owned outright a treasure that previously he could only have dreamed of. As Louis Hyman notes in his history of consumer credit in America,
Debtor Nation
, the system was so slick that it left everybody happy. Customers buying vacuum cleaners through the Republic Finance Company (RFC) paid interest of just $1.05 a month for five months, which seemed hardly anything, and yet it gave RFC and its shareholders a return of 62 percent on their money. On such happy mathematics was a new world built.

“Buy now, pay later” proved such an irresistible concept that soon people were using it to purchase all kinds of things—clothing, furniture, household appliances, bathtubs, kitchen cabinets, and above all cars. Installment buying filled American homes with gleaming products and its roads with cars. It made America the consumer paradise it has remained ever since.

All this left America in a peculiar position. It was by far the most economically dynamic of the four nations at the summer conference on Long Island, but also the least experienced. Its own central bank, the Federal Reserve, was just thirteen years old, and so cumbersome in structure as to be almost incapable of decisive action anyway. A portion of the responsibility for the Fed’s odd and hobbled nature lay, interestingly, with the father of America’s most celebrated young aviator. As a member of the House of Representatives Committee on Banking and Industry, C. A. Lindbergh had helped design the Fed. Like many other rural midwesterners, the senior Lindbergh felt a bitter antipathy toward
eastern bankers—he would have been appalled to know that his son would marry the daughter of a Morgan partner—and wanted the new Federal Reserve Bank’s powers diffused widely rather than invested in a single East Coast establishment. For that reason, he and his congressional colleagues decided not to have a single central bank, as in other countries, but to create a network of twelve independent regional banks, to be loosely overseen by the Federal Reserve Board in Washington.

It was—and remains still—a strange concoction. Although the twelve regional banks collectively form a single central bank and act on behalf of the government, they are at the same time private, individual, profit-making concerns owned by shareholders. Their principal function, from the government’s point of view, is to control the money supply, which they do by adjusting the discount rate—the rate of interest at which reserve banks lend to commercial banks. The discount rate is the foundation rate against which all other bank rates are calibrated.

The twelve scattered outposts of the Federal Reserve were in principle each of equal importance, but in practice the New York Fed under Benjamin Strong was by far the dominant player. As Allan H. Meltzer said of Strong in his history of the Federal Reserve: “He regarded the twelve reserve banks as eleven too many.” Under Strong, the New York Fed exploited its many advantages, notably that it was larger than any of the other reserve banks and conveniently located in America’s financial capital. The Federal Reserve Board in Washington was still largely in the hands of fiscal incompetents, thanks to the inept and careless appointments of President Harding. Crucially, Strong won for the New York Fed the right to be the exclusive agent for the United States in dealings with other countries. It became, in short, the de facto central bank—more or less exactly what Congressman C. A. Lindbergh had been determined to avoid.

For five days, the four bankers met under a cloak of secrecy. They issued no public comments. Indeed, they wouldn’t even confirm that they
were
meeting—rather extraordinary considering that they were making decisions
that would determine the direction of world finances for years to come. What exactly they discussed isn’t known because no minutes were kept, but the problems that lay before them largely came down to a single issue: gold.

The international banking system remained almost obsessively devoted to the venerable but rather creaky mechanism known as the gold standard. A gold standard is an appealingly simple concept. Under it, any paper money in circulation is supported by gold reserves. When America was on the gold standard, a $10 bill could be exchanged for $10 of gold, and vice versa. It was gold, in other words, that gave value to the otherwise worthless slips of paper known as money. A gold standard had certain limitations—most obviously, the amount of money in circulation was limited by the amount of gold that had been discovered—but it had many compensating attractions that endeared it to bankers. It made inflation almost impossible since governments couldn’t just print money. It kept the management of exchange rates out of the hands of politicians with their narrow short-term interests. It promoted price stability and, by and large, kept the heavy wheels of international trade turning. Above all, a gold standard had a huge psychological importance. It worked. It had worked for a long time. It was what was known.

The problem was, it wasn’t working very well now. Half of all the gold in the world was in the United States, mostly behind a ninety-ton steel door in a five-story vault deep beneath the Federal Reserve Bank of New York in lower Manhattan. This was not actually a terrifically good thing. It might seem like a great idea to have all the gold, but in fact that would mean that other countries couldn’t buy any more of your products because they would have no gold of their own to pay for it with. In the interests of trade and a healthy global economy, gold should circulate. Instead, it was accumulating—steadily, relentlessly—in a country that was already better off than all the countries of Europe put together.

Prudence, not to mention simple decency, dictated that America should help its European friends. It was in America’s interest to keep international trade rolling along. So Strong decreed that the Federal
Reserve would cut its discount rate from 4.0 percent to 3.5 percent, to encourage holders of gold to move their savings to Europe, where they would enjoy higher returns. That in turn would bolster European reserves, help stabilize European currencies, and boost trade overall. Strong gambled that the American economy could absorb the stimulus of a small rate cut without going crazy. It would prove to be a spectacular miscalculation.