Wednesday, June 13, 2012

Great, not good

Great, not goodShawshank, VA 6/13/12 (StreetBeat) -- A tale from long ago…
It can be said that the Roaring Twenties came to an end at the corner of Wall Street and Broad Street in Manhattan in late October 1929. That’s when and where the stock market began, in no uncertain terms, its epic collapse. It was the decisive decline in the stock prices that set in motion the chain of events that led to depression.

But it can also be said that it wasn’t until early May 1931, when trouble in the financial district of Vienna, Austria reverberated throughout the world economy, that the depression truly deserved to be called “Great”.

Oesterreichischekreditanstalt Kreditanstalt fur Handel und Gewerbe in Wein, (Kreditanstalt for short), was a Rothschild bank based in Vienna; it was one of the oldest and most respected banks in Austria. Baron Louis von Rothschild was in charge of the bank and in October 1929 he sought to shore up its balance sheet by merging with a large but crippled bank called Bodenkreditanstalt. As it turns out this was a big mistake for the Baron and the world economy was all the worse for it.

In early May 1931 Kreditanstalt was due to publish its calendar year 1930 accounting results. But they were unable to do so as scheduled because the bank’s English auditor had discovered a slew of misstatements in the accounts of the acquired bank, Bodenkreditanstalt. On May 11 the Rothschild’s bank shocked both investors and depositors when it announced that it had a 1930 year end loss of 140 million shillings; said to be the equivalent of 31.9 tons of gold, which mattered because the world’s currencies were on the gold standard; backed and valued by the shiny metal. The bank’s loss exceeded its total capitalization. A run on Kreditanstalt began immediately. On May 13 there were riots on the street in front of the failed bank as fears spread that depositor savings had vanished. Bank runs spread throughout Austria. The National Bank of Austria did not want such a large bank to collapse and loaned Kreditanstalt 152.5 million shillings in an effort to prevent that outcome. But as other banks also turned to the National Bank for help Austria was soon tapped out. They had to appeal to other countries for help. Then things got tricky.

France was the strongest country on the continent, but the price they set for helping out Austria, the dissolution of their customs agreement with Germany, was deemed to be too high a bar. So a loan involving the Bank for International Settlements (BIS), the Bank of England and the US Federal Reserve was put in place in an effort to keep the banking trouble from seeping outside Austria. But bank runs were already underway in Hungary and when the German Finance Minister said on June 7 that the Austrian banking crisis would spread to his country within sixty days, the bank runs immediately began there as well. The already fragile German banking sector was now under siege; foreign banks were rapidly liquidating positions and demanding immediate redemptions on its German securities.

In short order Austria had burned through all of its international loans; on June 17 they left the gold standard and defaulted on their obligations. Germany was on the ropes. On June 20 US President Hoover called upon the community of nations to institute a one year moratorium on intergovernmental payments in order to ease the pressure on Germany, whose finances were additionally strained by its war reparations. The “Moratorium Rally” boosted stock markets around the world, but only temporarily so. On July 20 a story in Time magazine noted that “Hope engendered by the Moratorium and the Moratorium Market on the world exchanges failed to find reflection in important business indicators up to last week. Important straws showed that Depression’s ill-winds were not yet blown out.”

July 20 was also the date of a conference in London to discuss the European debt crisis, US Treasury Secretary Andrew Mellon was there. Surprisingly the French, who had up till then been playing hardball, proposed that they, the British, and the Americans should lend Germany $500 million. Mellon thought the US should go along with the plan. He figured that if the US did not back the idea the French could lay the blame for any trouble at the feet of the US. But Hoover refused. Instead he inquired at the Fed, the Comptroller of the Currency and at the Bank of England, about the size of the German debt that was at risk for US and British banks; $5 billion was the answer, at a time when a billion was a lot of money. Hoover also determined that Germany and other countries in Eastern Europe were only able to make ends meet by using creative accounting techniques. Years later Hoover recalled, “It was now evident why the European crisis had been so long delayed. They had kited bills to A in order to pay B and their internal deficits. I don’t know that I have ever received a worse shock. The haunting prospect of wholesale bank failures and the necessity of saying not a word to the American people as to the cause and the danger, lest I precipitate runs on our banks, left me little sleep. The situation was no longer one of helping foreign countries to the indirect benefit of everybody. It was now a question of saving ourselves.” Lending more money was not the solution, thought the President. The French insisted, Secretary Mellon prodded, and a group of New York bankers complained, that the President should loan Germany the money. But Hoover was said to be determined not to make the American taxpayer pay for the mistakes of the bankers. Maybe he thought the moratorium would hold back the tide, or maybe he just miscalculated, but whatever the case, the die had been cast.

Events accelerated from that point forward and what seems clear is that national self preservation was a theme. On July 24 France began to withdraw huge amounts of gold from British banks; capitalizing on the benefit that goes to the first mover. Other nations soon followed suit. The gold was the asset that offset British loans to Germany and other nations in Central and Eastern Europe. The pound was under intense pressure. The Bank of England raised rates to support their currency; it did not help. In August they borrowed money from US banks. Not enough though to plug the hole created when Germany left the gold standard and defaulted; Poland, Romania, Czechoslovakia and Hungary also went that route. The balance sheets of the British banks were a disaster area. Wall Street banks may have had sizable trades in Germany and the like, but they had massive investments in the City of London. Bank of England Governor Montagu Norman assured the Dutch central bank chief that England would not leave the gold standard. Yet, two days later, on September 21, England did just that; which meant they were effectively defaulting on its foreign obligations. It was a devastating blow to the US banking system. There had been about thirteen hundred bank failures in 1930, but in 1931 there were 2,300, and three quarters of those came after the English default, in just a bit more than three months.

In the September 28 issue Time magazine reported, “Last Monday, all businessmen were shocked to read in their morning papers that the British pound sterling was no longer based on gold. The Tokyo Stock Exchange had announced it would not open. Tokyo was followed by Bombay, Calcutta, Johannesburg, London, Berlin, Amsterdam, Copenhagen, Vienna, Oslo, Stockholm, Brussels and Athens. The Paris Bourse opened, but limited all trades to 5% of all holdings and no dealing in foreign exchange. Montreal’s Exchange opened similarly restricted. The New York Stock Exchange remained open, but as in dark November 1929, short selling was forbidden. In the artificial market thus created, stocks gyrated unsteadily, closed higher; bonds closed at lows for the year.”

When 1931 began there was some hope that the depression was set to abate. In January there was a major oil discovery in east Texas. By the end of February the Dow Jones Industrial Average was up more than twenty percent from its December 1930 low. Things were looking up; literally, the Empire State Building was set to open on May 1. Sure the Unemployment Rate was a problem, the annualized rate for 1930 was 8.9%, but it had been several points higher than that just before the turn of the century; the labor market was bad but not unprecedented.

Then there was the failure of Kreditanstalt and the chain of events that it spawned. In the US that meant that banks closed at a more rapid pace, the unemployment rate just about doubled during 1931, rose to a high of 25% two years later and was still above seventeen percent at the end of the decade.

Kreditanstalt hurt the world economy, but it killed the little confidence that still remained. And, maybe more than anything else is what made the depression of the thirties Great.

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