1. Cosmology of the Bubble

The Lord giveth increase, but man devised credit.

Mass delusions are not rare. They salt the human story. The hallucinatory types are well known; so also is the sudden variation called mania, generally localized, like the tulip mania in Holland many years ago or the common-stock mania of a recent time in Wall Street. But a delusion affecting the mentality of the entire world at one time was hitherto unknown. All our experience with it is original.

This is a delusion about credit. And whereas from the nature of credit it is to be expected that a certain line will divide the view between creditor and debtor, the irrational fact in this case is that for more than ten years debtors and creditors together have pursued the same deceptions. In many ways, as will appear, the folly of the lender has exceeded the extravagance of the borrower.

The general shape of this universal delusion may be indicated by three of its familiar features.

First, the idea that the panacea for debt is credit.

Debt in the present order of magnitude began with the World War. Without credit, the war could not have continued above four months; with benefit of credit it went more than four years. Victory followed the credit. The price was appalling debt. In Europe the war debt was both internal and external. The American war debt was internal only. This was the one country that borrowed nothing; not only did it borrow nothing, but parallel to its own war exertions it loaned to its European associates more than ten billions of dollars. This the European governments owed to the United States Treasury, besides what they owed to one another and to their own people. Europe’s attack upon her debt, both internal and external, was a resort to credit. She called upon this country for immense sums of private credit—sums which before the war had been unimaginable—saying that unless American credit provided her with the ways and means to begin moving her burden of debt she would be unable to move it at all.

Result: The burden of Europe’s private debt to this country now is greater than the burden of her war debt; and the war debt, with arrears of interest, is greater than it was the day the peace was signed. And it is not Europe alone. Debt was the economic terror of the world when the war ended. How to pay it was the colossal problem. Yet you will find hardly a nation, hardly any subdivision of a nation, state, city, town or region that has not multiplied its debt since the war. The aggregate of this increase is prodigious, and a very high proportion of it represents recourse to credit to avoid payment of debt.

Second, a social and political doctrine, now widely accepted, beginning with the premise that people are entitled to certain betterments of life. If they cannot immediately afford them, that is, if out of their own resources these betterments cannot be provided, nevertheless people are entitled to them, and credit must provide them. And lest it should sound unreasonable, the conclusion is annexed that if the standard of living be raised by credit, as of course it may be for a while, then people will be better creditors, better customers, better to live with and able at last to pay their debts willingly.

Result: Probably one half of all government, national and civic, in the area of western civilization is either bankrupt or in acute distress from having over-borrowed according to this doctrine. It has ruined the credit of countries that had no war debts to begin with, countries that were enormously enriched by the war trade, and countries that were created new out of the war. Now as credit fails and the standards of living tend to fall from the planes on which credit for a while sustained them, there is political dismay. You will hear that government itself is in jeopardy. How shall government avert social chaos, how shall it survive, without benefit of credit? How shall people live as they have learned to live, and as they are entitled to live, without benefit of credit? Shall they be told to go back? They will not go back. They will rise first. Thus rhetoric, indicating the emotional position. It does not say that what people are threatening to rise against is the payment of debt for credit devoured. When they have been living on credit beyond their means the debt overtakes them. If they tax themselves to pay it, that means going back a little. If they repudiate their debt, that is the end of their credit. In this dilemma the ideal solution, so recommended even to the creditor, is more credit, more debt.

Third, the argument that prosperity is a product of credit, whereas from the beginning of economic thought it had been supposed that prosperity was from the increase and exchange of wealth, and credit was its product.

This inverted way of thinking was fundamental. It rationalized the delusion as a whole. Its most astonishing imaginary success was in the field of international finance, where it became unorthodox to doubt that by use of credit in progressive magnitudes to inflate international trade the problem of international debt was solved. All debtor nations were going to meet their foreign obligations from a favorable balance of trade.

A nation’s favorable balance in foreign trade is from selling more than it buys. Was it possible for nations to sell to one another more than they bought from one another, so that every one should have a favorable trade balance? Certainly. But how? By selling on credit. By lending one another the credit to buy one another’s goods. All nations would not be able to lend equally, of course. Each should lend according to its means. In that case this country would be the principal lender. And it was.

As American credit was loaned to European nations in amounts rising to more than a billion a year, in the general name of expanding our foreign trade, the question was sometimes asked: “Where is the profit in trade for the sake of which you must lend your customers the money to buy your goods?”

The answer was: “But unless we lend them the money to buy our goods they cannot buy them at all. Then what should we do with our surplus?”

As it appeared that European nations were using enormous sums of American credit to increase the power of their industrial equipment parallel to our own, all with intent to produce a great surplus of competitive goods to be sold in foreign trade, another question was sometimes asked: “Are we not lending American credit to increase Europe’s exportable surplus of things similar to those of which we have ourselves an increasing surplus to sell? Is it not true that with American credit we are assisting our competitors to advance themselves against American goods in the markets of the world?”

The answer was: “Of course that is so. You must remember that these nations you speak of as competitors are to be regarded also as debtors. They owe us a great deal of money. Unless we lend them the credit to increase their power of surplus production for export they will never be able to pay us their debt.”

Lingering doubts, if any, concerning the place at which a creditor nation might expect to come out, were resolved by an eminent German mind with its racial gift to subdue by logic all the difficult implication of a grand delusion. That was Doctor Schacht, formerly head of the German Reichsbank. He was speaking in this country. For creditor nations, principally this one, he reserved the business of lending credit through an international bank to the backward people of the world for the purpose of moving them to buy American radios and German dyes.

By this argument for endless world prosperity as a product of unlimited credit bestowed upon foreign trade, we loaned billions of American credit to our debtors, to our competitors, to our customers, with some beginning toward the backward people; we loaned credit to competitors who loaned it to their customers; we loaned credit to Germany who loaned credit to Russia for the purpose of enabling Russia to buy German things, including German chemicals. For several years there was ecstasy in the foreign trade. All the statistical curves representing world prosperity rose like serpents rampant.

Result: Much more debt. A world-wide collapse of foreign trade, by far the worst since the beginning of the modern epoch. Utter prostration of the statistical serpents. Credit representing many hundreds of millions of labor days locked up in idle industrial equipment both here and in Europe. It is idle because people cannot afford to buy its product at prices which will enable industry to pay interest on its debt. One country might forget its debt, set its equipment free, and flood the markets of the world with cheap goods, and by this offense kill off a lot of competition. But of course this thought occurs to all of them, and so all, with one impulse, raise very high tariff barriers against one another’s goods, to keep them out. These tariff barriers may be regarded as instinctive reactions. They do probably portend a reorganization of foreign trade wherein the exchange of competitive goods will tend to fall as the exchange of goods unlike and noncompetitive tends to rise. Yet you will be almost persuaded that tariff barriers as such were the ruin of foreign trade, not credit inflation, not the absurdity of attempting by credit to create a total of international exports greater than the sum of international imports, so that every country should have a favorable balance out of which to pay its debts, but only this stupid way of people all wanting to sell without buying.

The life history of delusions, how they get born, grow up, grow old and die, would be an interesting study. The beginning and growth of this one may be easily traced. War, discovery and coincidence, all three, produced the occasion.

It took the war to discover in this country a power of production amazing to the world and no less to ourselves. We have forgotten how incredible it was. During the first few weeks of the war we were in a panic at the thought that to find money for their combat the nations of Europe might have to sell their holdings of American securities. If they were offered for sale on the New York Stock Exchange we should have to buy them.

Now, the total amount of Europe’s holdings of American securities did not exceed five billions of dollars. Yet the prospect of having to repurchase five billions of American stocks and bonds from abroad was so terrifying that some of the elder international bankers in Wall Street proposed that this country should suspend gold payments. That is how little we knew of our own power. No one could have imagined that besides bailing our securities out of Europe, which we did on rising Stock Exchange quotations, we were about to spend twenty-five billions for participation in Europe’s war and lend our European associates more than ten billions at the same time—all in less than five years. To the world at large this was like the discovery of an infinitely rich new continent upon the explored earth; to us it was an astounding self-revelation.

The coincidence was that after many years of blundering toward it, and only a few months before the beginning of the war in Europe, we had found the formula for the most efficient credit machine that was ever invented. This was the Federal Reserve System. The law creating it was enacted in December, 1913. The extraordinary merit of the idea was that it contemplated for the first time a flexible currency to expand and contract in rhythm with the demands of trade and industry. Business to generate its own finance. That was the idea, and it worked. But as it worked that way, the credit resources of the old underlying national bank system and of the forty-eight separate state banking systems, hitherto employed to finance business through its seasons and cycles, were very largely released for other purposes, whatever they might be. Purposes of investment, promotion and speculation.

The new order arrived just in time. Without it we should not have been able so easily to receive our securities back from Europe, nor to finance the war trade, nor to make those early private loans to the combatant nations. An Anglo-French loan for $500,000,000 was the first notable test of its strength. And no sooner was it tried and found answerable in hundreds of millions than it had to be tested in tens of billions to finance the war loans of the United States Government, borrowing both for itself and our European associates at the same time.

When the war was over this country was paramount in two dimensions. Its industrial power was apparently limitless and it had the finest credit machine in the world. Certainly these ingredients were potent; and the road was strange.

It had long been the darling theme of a few world minds among us that as a people we should learn to “think internationally.” We never had. Then suddenly we found ourselves in the leading international part, cast there by circumstances, with no experience, no policy rationally evolved, no way of thinking about it. To “think internationally”, if it had ever been defined, was a way of thinking not of ourselves alone, but of others too, as all belonging to one world. In our anxiety to overtake this idea we overran it; international-mindedness became a way of thinking not of ourselves first but of the world first, of the other people in it, and of our responsibilities to them. No nation ever did think that way. If a nation did it would not long endure. To suppose this nation in its right mind could or would was the first sign of the oncoming delusion.

A variety of influences, incongruous among themselves, ran together to bring it on. There was the sentimental influence first. For nearly two years after the armistice the American Government continued making loans to European countries for their general relief, extending them even to the side that was enemy, and did this with unlimited popular sanction. At the same time private assistance was offered and received on sentimental grounds. Societies were formed to adopt European towns and villages. The recovery of Europe was much more than our economic concern; we made it our emotional anxiety. Internationalism as a political cult seized the occasion to press its propaganda upon a receptive national mind. Friends of Europe organized themselves into eminent groups to support the European thesis for war debt cancellation at the expense of the American taxpayer. The direct influence of Europe was very powerful. In developing the thought of our unlimited moral and economic responsibility for the rehabilitation of Europe there was but one Old World voice; it spoke continually in all European languages, thus preparing, whether consciously or not, a fabulous source of credit. And at last American finance, as might have been foretold, went international, with a body of highly accented doctrine, some of it quite unsound, yet very appealing to the self-interest of American agriculture and American industry, both in a nightmare of surplus and easily persuaded that the only solution was in foreign trade, bought with American credit.

Neither agriculture nor industry cared how it was bought, only so long as some one else seemed to be paying for it. In the end everybody paid for it. The loss that fell upon the private investor fell also upon the whole country. Those foreign outlets for the surplus we were so anxious to get rid of turned out to be very costly.

To say there was no way with our surplus but to lend it away is simply to say that at this time our imagination failed. We kept thinking of surplus credit, and there is no such thing, short of total human satiety. That we had power to produce more food than we could eat ourselves, or more automobiles than we could use ourselves, was not a sign of surplus except in a particular, unimaginative sense. The power of production is in itself infinitely versatile. If there is more of it than we need to satisfy our immediate wants, then instead of using it to produce a surplus of goods to lend away in the foreign trade we may use it to perform prodigious collective works for the future. Or by economic and financial engineering we may convert it into credit and conserve it, as wild water is conserved, behind dams, against a time of famine. One way to convert and store it would be to pay off the public debt so that to meet any emergency thereafter the government should have a free, tremendous borrowing power, with no worry about its budget. But all the time it was easier to let it run away in happy torrents.

Obsessed with the thought of having a surplus of goods and a surplus of credit that we were obliged to lend, only to be rid of them, still there was no surplus in this country of good housing for people of low income in the cities. There was and is enormous need for such housing. The credit with which to meet it is difficult to command. Yet American credit was loaned freely to other countries for that purpose, notably to Germany. Capital borrowed on public credit to replace slum dwellings with model tenements may not be very profitable. It seldom is. But if we use our own capital for that purpose, even though it be lost, still we have the model tenements. If we build pyramids with our own credit at least we have the pyramids to enjoy; if we use our credit for works of private profit that turn out badly, the creditors who loaned the credit may send the sheriff to sell the property into new hands for what it will bring, and although we have wasted some credit, we have the externalized corporality of it entire.

But if we lend our credit to foreign countries and they build pyramids with it, we have to spend money in foreign travel even to look at them; and if we lend our credit for skyscrapers and railroads and power plants to be built in foreign countries and these turn out badly we cannot send the sheriff to seize them. Where is the State of Minas Geraes? You would not be expected to know. We loaned sixteen millions of American credit to the State of Minas Geraes, and all we know about it is that the bonds of Minas Geraes are in default. If Amarillo, Texas, had lost sixteen millions of American credit we should at least know where to go to look for it.

It is true that while what we called surplus American credit was vanishing abroad in sums rising to two billions a year, going to places we had never heard of and for purposes that sometimes were not even stated, public borrowing in the United States also was extravagant. Many cities and States were borrowing perhaps more than they could afford. Private borrowing in the United States at the same time may have been as reckless as private borrowing anywhere else. Say it was. There is still the difference between knowing and not knowing your debtor; between knowing and not knowing what he did with it, between the right of the creditor in his own country to lay hands on the property and his inability to act upon the news that his Brazilian bond is in default. He will receive the news by a printed form from the same American banking house that sold the bonds, now acting as Brazil’s fiscal agent. Of the many Brazilian bonds floated in this country he may happen to have one of the issue named in the banker’s prospectus: “$25,000,000 United States of Brazil (Central Railway Electrification Loan of 1922) 30-year 7 per cent. Gold Bonds.” The bonds are in default and the Central Railway was never electrified. What was done with the credit only Brazil knows. The bankers do not know. And what can be done about it is nothing.

The holder of a foreign bond must have bought it on faith. There was no other way. How could the individual investor examine for himself the economic resources of a foreign country and analyze its budget, or enter into the private accounts of a foreign corporation, try its balance sheet, and form a judgment, besides, of its prospects in the field?

On the science, wonder and romance of American investments abroad, on the individual investor’s perilous position in faith and on the moral responsibility of the banker, a very beautiful essay was written by the late Dwight W. Morrow, who had been a member of the house of J. P. Morgan and Company, international bankers; then Ambassador to Mexico, later United States Senator. It was printed in Foreign Affairs, an American quarterly of international vision, in the year 1927 (a year in which our loans to foreign countries exceeded the total borrowing of all American States, counties, townships, districts, towns, boroughs and cities). This essay became at once a classic of the kind, referred to continually by all who wanted a theory or a philosophy of what we were doing. He was on a train, reading a Chicago newspaper, and he counted the foreign bonds listed in its daily bond table. The number was 128, where ten years before, as he learned by inquiry, there had been only six. He wrote:

“Examining that long list of 128 bonds I discovered that governments, municipalities or corporations of some 30 different countries were represented—countries scattered all over the world. The list included the countries of our own hemisphere, Canada, Cuba, Brazil, Argentina, Chile, Peru, Bolivia, Uruguay; nations abroad with whom we fought and against whom we fought; governments in the Far East such as Japan and the Dutch East Indies; and cities as widely separated as Copenhagen and Montevideo, Tokio and Marseilles.

“The contemplation of the extent and variety of America’s investments in foreign bonds gives rise to three questions: Who buys these bonds? Why do they buy them? What do they get when they have bought them?”

These questions he set himself to answer. From statistical evidence he concluded that more than four buyers in every five were small investors and bought them in amounts from $100 up to $5,000. On this he said: “The investment in these foreign loans represents the savings of the person who spends less than he produces and thus creates a fund which he is able to turn over either to a domestic or to a foreign borrower. . . . When we talk about the person who is investing in foreign bonds we are not talking about a great institution in New York or Chicago or Boston. We are talking about thousands of people living in all parts of the United States. We are talking about schoolteachers and army officers and country doctors and stenographers and clerks.”

Then the second question: Why do they buy foreign bonds? “Here,” he wrote, “statistics are of little value. . . . The considerations in the minds of most investors are, first, the safety of the principal, and, second, the size of the interest yield. It should be borne in mind that the investor is the man who has done without something. He has done without something that he might presently have enjoyed in order that, in the future, his family may have some protection when he is gone, or in order, perhaps, that a son or a daughter may go to college. This investor wants to be certain that he will continue to receive income on the bond which he buys. He wants that income as large as is consistent with safety. Above all, he wants the principal returned to him on the day of the maturity of the bond. It cannot be asserted, however, that sentiment plays no part in our investments. It does. Many men in this country bought German bonds, after the successful launching of the Dawes Plan, not only because the rate of interest was attractive and the principal seemed secure, but because they felt that they were thus associating themselves in a fine venture to help Europe back on her feet.” Sentiment allowed its due weight, yet Mr. Morrow supposed safety was always the first consideration. And he asked: “If that be true, how is the investor to form an intelligent judgment as to the safety of his investment? If he should be asked this question, I think that he would put in the very forefront of his reasons for making the investment the fact that he had confidence in the banker who offered him the investment. This throws a heavy responsibility upon the banker.”

Thirdly, the question: What does the buyer of a foreign bond get? On that he continued: “In 1924, 40 persons in a western city put $100 apiece into a Japanese bond maturing in 1954. What did those people get for their money? They got a promise. And, mark you, that promise was the promise of a group of people associated together on the other side of the earth. Moreover, so far as the promise relates to the payment of the principal of the bond, the promise does not mature in time to be kept by the particular members of the group who originally made it. It is a promise designed to be kept by the children of men now living. Yet somehow or other, the banker who offers that bond and the investor who buys that bond rely on the people of Japan taxing themselves a generation from now in order to pay back the principal of that bond to the children of the person who invests in the bonds today. At first blush it is a startling idea. It is particularly startling at this time when so many people are saying that the various nations of the earth have lost faith in each other. Here we have printed in a middle western newspaper the record of the day’s dealings in 128 foreign bond issues. Individuals in America are taking their own money, with its present command over goods and services, and surrendering that command to nations on the other side of the earth, and they receive in exchange for it a promise. The question may be asked: Nothing more than a promise? To which the answer may be made: Nothing less than a promise. . . . Those nations who are borrowing in America because they actually need the money for a constructive purpose, who have a solidarity of national feeling and a sense of the meaning and value of national credit, who are not incurring obligations beyond what may fairly be considered their capacity to handle them—all those nations may be expected to pay their debts. Here again the responsibility rests heavily upon the investment banker recommending investments. The banker must never be lured, either by the desire for profit or the desire for reputation, to recommend an investment which he does not believe to be good.”

Two years later the crystal burst. Within four years the loss upon American investments abroad was incalculable.

Of the new Latin-American bond issues that had been recommended to investors by the very best Wall Street banks and their bond-selling affiliates—of these alone, fifty-six issues, aggregating more than eight hundred millions of dollars, were in default; and the fate of others not actually in default was very uncertain. In Europe, with a general moratorium on war debts and reparations, with a private moratorium running to Germany, another one to Austria, another one to Hungary, and with war debts and private debts involved in one great maelstrom of political controversy, the value of the American investment, present or ultimate, was very indefinite. Bonds of the German Government selling on the New York Stock Exchange at thirty to sixty cents on the dollar, bonds of the State of Prussia at twenty-five cents, bonds of the City of Berlin at twenty cents, Hungarian bonds at fifteen to forty cents, many of the private bonds of European industry a little better or a little worse; and these were all bonds that had been eminently sold to the American investor within five or six years at ninety, ninety-five and one hundred.

Then one by one the international bankers appeared before committees of inquiry of the United States Senate, all saying they thought the bonds were good and all alike disavowing further responsibility. They had not guaranteed the bonds or the validity of them. They were not responsible for how the money was spent or misspent; the borrowers were responsible. And as for the foreign bond delirium in this country, that was something the people, that is to say, the private investors, had done to themselves.

Before the Committee on Finance of the United States Senate, the head of the second largest national bank in Wall Street, who represented also the most aggressive bond-selling organization in the world, appeared and said: “We are merchants. With respect to bonds generally, we are merchants.”

A member of the most powerful private international banking house said to the same committee: “We are merchants. That is what we are, just like any merchant, in the grain business, in the cotton business, or anything else.”

The head of the largest national bank in Wall Street, one that owns also a very powerful bond-selling organization, appeared before the Senate Committee on Manufactures. The committee was hearing bankers on the question of establishing a national economic council and it was asking him what the bankers had done to restrain a wild use of American credit before the collapse. He said: “Speculation was in the air, and the speculators wanted to buy, buy, buy, and the bankers and brokers dealing in securities supplied that demand. . . . In other words, I do not think you would be justified in holding the bankers responsible for the wide speculative craze that worked through the country. I think they were trying to supply what the customers wanted. . . . I think the banker is like the grocer. He supplies what his customer wants.”

And to that committee the head again of the second largest national bank in Wall Street, who appeared twice in Washington—looking at the same subject, namely, the delirious use of American credit in foreign securities—said: “It came about in part by reason of the public’s interest in, and fever and fervor for, investments and speculation, if you will. It came about as a result of the demands of foreign countries for funds and an obvious appetite on the part of the American public for investments therein. The investment banking community became one of the tools by which the demands on each side operated to satisfy their requirements.”

Grocers, merchants and automatic tools. And the people Mr. Morrow wrote about all did it to themselves. Their sudden appetite for foreign bonds was so voracious that if they had read in every case the banker’s prospectus, which few of them did, they perhaps would not have noticed the line in smaller type that always appeared at the bottom and read: “The information contained in this circular has been obtained partly from cable and other official sources. While not guaranteed, it is accepted by us as accurate.”

Not even the accuracy of the information was guaranteed by the banker.

The Senate Committee on Finance learned a good deal about the merchant banker trade. It learned how foreign bonds originate in Wall Street and how they get from there to the hands of the individual investor. As in trade generally, there are parts, three at least and sometimes four, corresponding to the parts, respectively, of manufacturer, jobber, wholesaler, retailer.

There is first the bank that discovers and originates the bond issue. Let the borrower be a foreign government. The bank undertakes to buy from the foreign government so many bonds of a certain character at 90, and to pay for them on maybe the tenth day following the public offering. This originating bank then calls in a jobbing group of two or three banks of its own rank and says to them: “Here is a good thing. We will share it with you at 90½.” So the jobbing group underwrites the bond issue at 90½, which is the first step-up. The jobbing group then forms a large syndicate of wholesalers, to whom it will sell the bonds at 92. This is the second step-up. The wholesalers know the retail trade; that is their business. Each wholesaler has a card index of retail bond dealers all over the country, with notations indicating about how many bonds of a certain kind each retailer may be expected to sell to the banks in his neighborhood and to the individual investors in his community. The wholesalers, by letter, telephone and telegraph, offer this new bond to the retail trade at 94, which is the third step-up, and the retailers will sell them to the public at 96½, so that the retailer’s profit will be 2½ per cent., which is the last step-up.

When all these arrangements are made, the jobbing group advertises the bonds in the newspapers and at the same time establishes on the curb market, or over the bank counters, a public quotation a fraction above the retail price, say, 96⅝. This is the public offering. The originating house delivers the bonds to the jobbers, who deliver them to the wholesalers, who scatter them widely to the retail trade, and that day thousands of bond salesmen begin to solicit the small-town bank presidents and all the people Mr. Morrow wrote about, to buy the bonds. As the bonds are sold, the money starts moving from the many local sources toward Wall Street. Ten days after the public offering the wholesalers settle with the jobbers and the jobbers settle with the originating house and the foreign government gets its money. There are variations of the price steps, and, if the bond issue is small and juicy, the jobbers may go direct to the retail trade or the wholesalers themselves may perform the jobbing function, so that there may be only three steps instead of four; but with such slight modifications, the method as described is standard.

The only risk the Wall Street banker takes, you see, is in judging the public appetite. If his judgment is good the bonds are sold and paid for before the foreign government gets the money. The desirability of that result explains the speed and high tension at which all the machinery works.

All of that the committee could understand. Given the point of view of the international banker, that he is like a grocer, and then the uncontrollable demand on the part of the American public for his merchandise, it could understand why representatives of Wall Street banking houses went frantically to and fro in the world, pressing American credit upon foreign governments, foreign cities, foreign corporations, soliciting them to issue bonds to satisfy that American appetite; why at one time twenty-nine such representatives were all soliciting a small Latin-American country to make a bond issue in Wall Street; even why American bankers paid large commissions, vulgarly mentioned as bribes, to influential private persons in foreign countries who could lead them to a new bond issue. It received with pleasure an acknowledgment of practical error from the head of a private banking house who said: “Yes, but it is also true that those things existed not only in Latin America, but the world over, relating to governments, municipalities and industrial concerns. In other words, the accumulation of capital in America was seeking an outlet. The bankers were the instruments of the outlet. They were the purveyors of capital. The bankers competed to a degree that in retrospect was wholly wrong. I am not speaking morally.”

And yet all the simplicity of light that could be brought to bear upon these points seemed only more and more to obscure one another. The committee became very uneasy about it. Given again that inebriate demand on the part of the American investor which obliged the merchant banker to search the world for foreign borrowers, why then was it necessary for the bankers to adopt the intensive merchandising methods of industry in order to dispose of their merchandise? One would suppose it had sold itself, even faster than it could be originated. Why were foreign bonds so expensively advertised? Why were they pressed upon the investor through costly, he-type selling organizations, by house-to-house canvass, even in some cases by radio ballyhoo? Questions to this point seemed always to embarrass the banker witnesses. The least indefinite answer either of the Senate committees got was made by the head of the foremost banking organization in Wall Street. He said: “Oh, undoubtedly salesmanship and advertising facilitate business; but you must remember that the banker cannot make that profit from his advertising and salesmanship unless the market is there to sell on, and unless the public is there to buy.”

One point was too clear. There was no American policy. First and last, exclusive of the loans by United States Government to its European war associates, private American credit to the incredible aggregate, roughly, of fifteen billions was loaned in foreign countries—without a policy.

If the State Department did touch foreign loans, it was with an ambiguous finger. Only once was the government openly positive, and that is how the State Department’s contact with foreign loans began. When the United States Treasury stopped making post-armistice loans direct to European countries they all turned to Wall Street and began there to borrow private credit very heavily, while at the same time they were refusing to go to the United States Treasury and fund their promissory war-time notes into long-term bonds, according to the terms of their war loan contracts. So the government declared that it would disapprove of private American loans to foreign countries that were unwilling to honor their obligations to the United States Treasury. The government could not forbid their borrowing in Wall Street; it could only express its disapproval. But that was enough. All the debtor nations then came and did with their war debts at the United States Treasury what they had agreed to do.

Out of this arose the practice, which still continues, of referring a foreign loan to the State Department before it is publicly offered, to see if the government has any political objection to it. If there is none, the State Department says so and the bond issue proceeds; but what the State Department says is negative only, and confidential. When the State Department says there is no political objection to a foreign loan it does not thereby approve of the loan, or assume any moral responsibility whatever. The bankers understand this. Nevertheless, as it became generally known that all foreign bond issues were first referred to the State Department, the idea somehow grew up in the popular mind that they were issued under the sanction of the State Department, which was never so.

By informality the government did effectively object to a loan Wall Street would have floated for the Franco-German potash monopoly. The reasons were obvious to all but the bankers. Before the war this had been a Prussian monopoly. The whole world was dependent upon Germany for an indispensable plant food, a fact which entered deeply into the calculations of the German militarists as to how they should run the world after the German victory. But after the war France had the potash beds of Alsace, by cession of Alsace-Lorraine, whereupon the French and Germans agreed to handle potash as a joint monopoly and divided between them the markets of the world. During the war potash in this country went from $40 to $400 a ton because we were cut off from the German supply and our soil was starving for it. Only ten years later and with American chemical science struggling to develop American sources of potash as a vital national possession, Wall Street, but for the objection of the government, would have loaned $25,000,000 of American credit to strengthen the Franco-German monopoly.

The enormous German borrowing in Wall Street, after the Dawes Plan loan, was a source of constant anxiety to the government, as it was to all observers whose motives were free and whose minds had not been seized by delusion. There was the danger, first, that if Germany’s external private debts went on growing they would come into conflict with her reparation debts to France, Great Britain, Belgium, and others, as at last they did; and the danger, moreover, that such extravagant borrowing would bring Germany’s whole financial structure to insolvency, as it did. Yet apparently there was nothing that could stop it.

S. Parker Gilbert, the American Agent General for Reparation Payments, under the Dawes Plan, addressed a public protest to the German Government, which he concluded by saying: “I have attempted to bring together in the foregoing pages the accumulating evidences of overspending and overborrowing on the part of the German public authorities, and some of the indications of artificial stimulation and overexpansion that are already manifesting themselves. These tendencies, if allowed to continue unchecked, are almost certain, on the one hand, to lead to severe economic reaction and depression, and are likely, on the other hand, to encourage the impression that Germany is not acting with due regard to her reparation obligations.”

That made no difference. Wall Street ignored the warning. Again, writing from Paris to American bankers, November 3, 1926, Mr. Gilbert said: “I am constantly amazed at the recklessness of American bankers in offering to the public the securities of German States on the basis of the purely German view of Article 248 of the Treaty of Versailles. It is a simple matter, of course, to get letters from the financial authorities of the German States setting forth the German point of view, and I can easily understand the willingness of the German authorities to sign letters stating the German point of view, but it does seem to me difficult to justify the action of the American bankers in offering the securities to the public on the basis of such letters, without giving the slightest hint that the German point of view is not accepted by the Allied governments, and that, in fact, the Allied point of view is diametrically opposed.”

Sir William Leese, of the Bank of England, supported Mr. Gilbert with an analysis of the representations being made to American investors in respect of two important German loans, and stated the following conclusion: “Upon this point both prospectuses are in my opinion substantially untrue and misleading.” One for the City of Hamburg and one for the State of Prussia.

And that made no difference. The State Department, though not objecting to any particular German loan, addressed a letter to the issuing houses in Wall Street, saying: “. . . It cannot be said at this time that serious complications in connection with interest and amortization payments by German borrowers may not arise from possible future action by the agent general and the transfer committee. . . . A further point which the department feels should be considered by you . . . is the provision of Article 248 of the Treaty of Versailles, under which ‘a first charge upon all the assets and revenues of the German Empire and its constituent States’ is created in favor of reparation and other treaty payments. . . . These risks, which obviously concern the investing public, should in the opinion of the department be cleared up by you before any action is taken. If they cannot be definitely eliminated, the department believes that you should consider whether you do not owe a duty to your prospective clients fully to advise them of the situation.”

But so long as the government did not positively object, Wall Street went on bringing out German bond issues, faster and faster—the bonds of German States, German cities, German regions, German industry, German agriculture, German ports, anything German. Moreover, it kept hundreds of representatives in Germany soliciting all of these sources for bonds to sell to the American public.

In much of our lending to Europe, particularly as it ran to Germany, there was a sense of gesture. American credit was the rich prodigal returning in a grand way from a far country to dazzle and reward the indigent ancestor. And whether it was that some of the sentiment discovered by Mr. Morrow in his small investors worked itself up to the Wall Street mind, or that Wall Street itself needed emotional reasons and naturally acquired them, the fact is that bankers themselves became assertively sentimental about Germany. It is true that thinking of the effect of reparation payments upon the new German debt they were creating here might have inclined them realistically to the well-known German view of reparations; but they went much further and considered the effect of reparations upon the hearts and minds of Germans born since the war and of Germans yet unborn.

This was discovered to the Senate Committee on Finance by one of its most eminent banker witnesses, who said: “Here we have in Germany to-day young men going into the universities of Germany who were not born when the great war started. Those young men see that not only must they pay, but their progeny and the progeny of their progeny, must pay, and go on for these generations in paying a debt for which they, as individuals, were not responsible. They feel that they are under a heavy yoke, and my impression is that there is growing, as a result thereof, rebellion against payment of the debt.”

Senator Reed asked this startling question: “Why should the progeny of Americans who had nothing to do with the war, the progeny of Americans who were not even alive, pay this war debt, and the progeny of the people who started it go scot free?”

The banker answered: “I grant you that that is quite unanswerable as an argument within itself.”

If at any time you had asked an international banker to say whether or not there was an American policy to govern foreign loans he would have said yes, and if you had asked what it was, he would have said: “More and more our prosperity is and will be dependent on foreign trade. American loans abroad represent an investment in foreign trade.”

This is not a policy. It is an idea only, largely fallacious as such. Here we have no state policy, as in France, that stipulates for political and economic advantages in return for credit loaned in other countries; nor is there here, as in England, the organized practice of tying up foreign loans with foreign contracts. American credit is loaned on the obscure presumption that trade will somehow follow; the borrowers, having got the credit, may do with it what they like.

Moreover, wherein our foreign loans do increase American exports, who is it that takes thought beforehand of how payment shall be received? Suppose the debtor offers to make payment in competitive goods that we do not want, and says he cannot pay in any other measure. That is happening. It is what is bound to happen when we lend American credit to foreign countries to increase their production of competitive goods; and the problem then is how we shall receive payment at all, if we keep a tariff against the exportable goods of our debtors.

But even that idea of buying foreign trade with American credit, to make outlets for the American surplus, was not consistently pursued. Take some typical instances.

With the American Government borrowing credit to lend at low rates of interest to people who will build ships, thereby to foster an American merchant marine, American credit is loaned in large sums to German shipping companies; they use it to build German ships in German shipyards, with German labor and German materials, to compete with American ships.

With American chemical science dimly in sight of its goal, which is to make this country independent of Germany’s synthetic chemistry, American credit is loaned to the German Dye Trust, whereby its offensive powers, in trade or in war, are strengthened.

If these are not cases in which we could not afford to lend American credit on any terms, still, where was the benefit to our own foreign trade? Lending very large sums of American credit to the Anglo-Chilean Nitrate Trust does neither increase the volume of American exports nor foreshorten the time in which we may hope by synthetic chemistry to free ourselves from dependence upon foreign sources of nitrogenous fertilizers and the essential chemical products of nitrate; and the same is to be said of loans of American credit to German and Italian corporations for the purpose of building nitrogen fixation plants. Lending forty million dollars of American credit to a foreign oil company, for drilling and exploration, can hardly be called an investment in our own foreign trade, nor a loan of one hundred and fifty million dollars of American credit to the Dutch East Indies to pay off its floating debt. It would be difficult to explain how lending large sums of American credit to the fabulous Swedish Match Trust, which in turn made loans to European governments in exchange for monopolistic trade concessions, benefited the sale of American goods in the foreign trade. Certainly a loan of American credit to a Latin-American republic to pay a debt it owed in Europe for armament had no beneficial trace in the American foreign trade. Or fancy any benefit to the American export trade from a loan of twenty millions to a German bank for the specific purpose, as stated by the bankers, “to finance German exporting corporations.”

Glance at the contradiction of lending very large sums of American credit for the purpose of extending, improving and financing Europe’s agriculture, with the American Government borrowing credit to support the price of American wheat because the European demand for American grain declined. The word for this may be one of unction or it may be cynical, from opposite points of view, but certainly there was no policy in it. If for any reason we were going to lend our credit to extend Europe’s agriculture, we should have been providing at the same time both the credit and the economic engineering to shrink American agriculture proportionately, without disaster to the farmer.

Loans to Europe, especially to Germany, to rationalize industry and introduce American methods of mass production could benefit American industry in the foreign trade only if you argued that what American industry needed for its own good was more competition.

But of all the ways in which the lending of American credit in Europe did not increase the American export trade, the one most extraordinary was that of lending our debtors the credit with which to make payment to us on their debt. American loans to Germany enabled Germany to pay reparations to the Allies; reparations from Germany enabled the Allies to pay interest on their war debts at the United States Treasury, hardly touching their own pockets. We were paying ourselves. For a long time this simple construction was denied and concealed in the elaborate confusions of finance. The Senate Committee on Finance kept asking its banker witnesses to face it. One of the best answers was by Otto H. Kahn, who said:

“There is no doubt that if Germany had not been able to borrow money it would have been unable, long since, to pay reparations, and, therefore, to that extent, it is a generally correct statement to say that out of the money which Germany borrowed it did pay reparations.”

Then at last the German Government itself, to prove Germany’s incapacity to pay, publicly declared that reparations had been paid only by borrowing and that if Germany could not continue to borrow she could not continue to pay.

That debt need never be paid, that it may be infinitely postponed, that a creditor nation may pay itself by progressively increasing the debts of its debtors—such was the logic of this credit delusion.

Since John Law and his Mississippi Bubble, individuals have been continually appearing with the same scheme in new disguise. The principle is very simple. You have only to find a way to multiply your creditors by the cube and pay them by the square, out of their own money. Then for a while you are Nabob. One fish cut up for bait brings three. Two of these cut up for bait bring eight, the cube of two. Four of these cut up for bait bring sixty-four, the cube of four. Sixteen of these for bait bring 4,096, and 256 of these, which is the square of sixteen, will bring 16,777,216, which is the cube of 256.

The fatal weakness of the scheme is that you cannot stop. When new creditors fail to present themselves faster than the old creditors demand to be paid off, the bubble bursts. Then you go to jail, like Ponzi, or commit suicide, like Ivar Kreuger.

There is nothing new in the scheme. What is new is that for the first time the whole world tried it. The whole world cannot put itself in jail, nor can it escape the consequences by suicide.

When the delusion breaks, people all with one impulse hoard their money, banks all with one impulse hoard credit, and debt becomes debt again, as it always was. Credit is ruined. Suddenly there is not enough for everyday purposes. Yet only a little while before we had been saying and thinking there was a great surplus of American credit and the only thing we could do with it was to export it. How absurd it sounds in echo. It was absurd at the time.

Our problem properly was, properly is, for a long time will be, how to find enough credit to perform the works that lie ahead of us, only such as are in sight. We already see that we shall have to recast the entire transportation machine, wherein is to be faced both a terrific loss of old capital and the necessity to provide in place of it enormous sums of new capital. We already know that we shall have to relate and organize in a rational manner our sources of energy by bringing the three hydrocarbons, coal, gas and oil, into a few immense pools, where they may be converted interchangeably into forms ideal for the several needs of life, industry and commerce, and whence they may be distributed, without waste, more and more efficiently, until fuel, heat, light and power shall become as cheap as water. We have our cities to make over, not to meet their future, but only to accommodate the change that has already occurred in the patterns and conditions of American life. There is no suburban area but must be reclaimed from its anarchy of free growth and recast to a regional plan by colossal engineering.

The new materials and methods discovered almost daily by science are creating obsolescence at a rate never before imagined. Notwithstanding the physical progress everywhere to show, the fact is that in contrast with the present state of technical and scientific knowledge and the power we possess, the country is more in arrears than it was a generation ago; it has much more to overtake. Many of the blue prints are ready and fading for want of credit.