Street at the end of 1928, president-elect Herbert Hoover grew nervous. He and the governors of the Federal Reserve decided to burst “the bubble.” The central bank raised interest rates from 3.5 percent at the end of 1927 to a high of 6.0 percent by the summer of 1929. The rate hike had the intended effect, and industrial output began to decline. Yet the stock market ignored the data and continued to go up until, famously, in October, it lost spectacularly.
Figure 4. U.S. bank loans, 1925–1941 (billions of U.S. dollars). Source: Federal Reserve System, Banking and Monetary Statistics, 1914–1941 (Washington, DC, 1941).
European central bankers, and particularly the British and Germans, met the market crash with enthusiasm. In theory, once Wall Street stopped siphoning gold from around the world, investment would return to them. Yet their expectations were frustrated because at that moment the global financial system lay under tremendous pressure. Banks around the world had begun to fail and had stopped lending altogether. Worse, as credit collapsed, the economy in many countries slipped from recession to depression.10
By 1930, the moment of truth came for the German economy. In October the former German financial official Hjalmar Schacht made a trip to the United States. He pleaded with the American people to accept a revision of reparations and forgive war debts. “Never before,” asserted Schacht, had “a conquering force first taken from the vanquished all that they had in colonies … and then demanded the conquered people … to pay still more.”11 If America took the lead in debt and reparations forgiveness, Woodrow Wilson’s ideal might get one last chance to succeed. But the American press wanted to talk instead about the upstart Nazi Party. They wanted a sense of who Adolf Hitler was and how he had become so popular so quickly. Frustrated, Schacht explained, “You must not think that if you treat a people for ten years as the German people have been treated they will continue to smile.… If the German people are going to starve, there are going to be many more Hitlers.”12
Without American loans, German authorities announced they could not make the next installment of reparations. Without reparations, the British and French could not repay their debts to America. Seeing that the global system lay on the brink of collapse, Herbert Hoover declared a oneyear moratorium on reparations and war debts, finally acknowledging what European authorities had argued since 1919. Hoover hoped that with time the Germans, British, and the rest of Europe might turn their economies around. None did.
Unfortunately, reparations represented only part of the problem. German municipalities also started defaulting on their loans, causing additional shocks to the global banking system. To slow the financial crisis, Berlin applied exchange controls to prevent gold from leaving its banks, as did nearly all Central European countries (Czechoslovakia, Bulgaria, Romania, and Yugoslavia).13 By the end of summer, 1931, the Bank of London was near panic as gold drained from it as well. Seeing no other alternative, on September 20, the British left the gold standard. “The struggle to bring the British pound back to par after the World War,” wrote the New York Times, “will rank among the epic contests of world finance. That struggle has failed.”14 The value of the pound finally dropped, losing 20 percent against the dollar. Almost immediately Sweden, Norway, and Egypt followed England off of gold. Many countries began to negotiate exchange rates bilaterally. In response, the United States suffered a new wave of bank failures corresponding to the financial crises in Europe, killing what had looked like a modest recovery in the first part of 1931.
The combination of Hoover’s moratorium and Britian’s move off of gold seemed to indicate the time had finally arrived to rethink the whole issue of reparations and war debt. In the summer of 1932, in Lausanne, Switzerland, leaders from the principal European countries gathered and, in a “gentlemen’s agreement,” decided that they would set aside German reparations once the British and French had “satisfied” their obligations to the United States. “We are still ready to cancel all debts due us,” explained Neville Chamberlain, then chancellor of the exchequer, “If the United States should decide to cancel all debts due her.”15
The gentlemen’s agreement launched an intense debate within the Hoover administration. On one side sat President Hoover, who considered his moratorium strictly a temporary “depression measure.” By contrast, his secretary of state, Henry Stimson, felt forgiveness “might really be the beginning of a recovery.” In a long conversation, he urged Hoover to accept it “without fear or rancor.” The two argued back and forth until Hoover exploded. “The European nations [are] all in an iniquitous combine against us!”
A frustrated Stimson did not know what more to say. “If [you really feel] that way, we [are] indeed on such different ground that I … ought not to be [your] adviser.”16 He tried to resign.
In the end, Hoover refused to accept the resignation. But he also refused Stimson’s advice. The moratorium remained temporary, and the disagreement strained the two men’s relationship thereafter.
Ultimately, Europe settled the issue on its own. Germany defaulted on reparations, and when the 1932 war debt came due only the British paid in full. The next year another payment came due, and this time no one paid. American loans to Europe, whether for war or peace, had been a cause of, and ultimately a casualty of the depression.
As he often did in his long career, the journalist Walter Lippmann captured succinctly the transition that had occurred between 1919 and 1933. “The theory was,” wrote Lippmann of the thinking in 1919, “under free trade, national frontiers would mark off cultural and local interests, but that economic opportunity would not be determined by political boundaries.” Ideally, once “there were no great barriers to trade at the frontiers, the problem of the frontiers would cease to be so troublesome.” By 1933, that charter had failed. Rather than cooperate economically, the victors had “insisted upon payments from the defeated powers and upon payments from one another,” with “a destructive and deflationary effect upon world commerce.” Now, in the face of depression, all nations seemed to agree that governments “must organize industry and agriculture and finance to a much greater degree than they have ever been organized before.” To do this “it follows inevitably that the system must be protected against external forces that cannot be controlled”—that is, the domestic economy had to be shielded from the vicissitudes of global competition. Thus, the world had entered into a new phase, a “Second Reconstruction” that combined political nationalism with economic nationalism. “Along these general lines the Second Reconstruction is now being carried out,” he concluded. “Will it bring that peace and that prosperity which the First failed to establish? Who can say?”17
* * *
At the end of 1932, Franklin Roosevelt beat Herbert Hoover handily in the presidential election. As it turned out, MacArthur, Eisenhower, Clay, and Stimson all had front-row seats to the unfolding drama of the Roosevelt administration. MacArthur and Eisenhower had been in Washington for several years before the election. “He had greatly changed and matured since our former days in Washington,” MacArthur said of Roosevelt in 1933.18 Clay had coincidentally received orders to report to Washington almost immediately after Roosevelt’s inaugural. He would supervise all river and harbor projects for the Army Corps of Engineers. For the first time (but not the last), all three future proconsuls found themselves together in the same place. Stimson ultimately joined the Roosevelt administration for a second stint as secretary of war in 1940.
In solving the Great Depression, Roosevelt tended to play to his strengths. He was first and foremost a politician, not an economist, and he tended to answer economic questions in political rather than technical terms. “If I read the temper of our people correctly,” he explained in his inaugural, “we now realize as we have never realized before our interdependence on each other; that we cannot merely take but we must give as well; that if we are to go forward, we must move as a trained and loyal army
