Figure 5.1, reproduced from chapter 2, recalls the seismic shift in the exchange rate between the U.S. dollar and the British pound triggered by the war. During the rst half of 1914 sterling varied narrowly around the mint parity of $4.8665—the rate never fell below $4.85 per pound and never rose above $4.89. Gold arbitrage restrained the exchange rate.* When mobilization for war impeded gold shipments across the Atlantic the pound broke through the old barrier and left all memory behind. After July the dollar price of sterling fluctuated like an internet stock.
The gure also shows that the price of sterling disappeared from view between August 1 and August 7. On August 3 the Wall Street Journal
explained its failure to report prices: “Quotations are more di cult to be had than at any time since the present situation developed. Business is entirely a matter of private negotiation.”401 The newspaper resumed regular quotations with a price of $5 for August 8.402 Trades in foreign exchange were still done for small amounts, but dealers had already labeled $5 as a commercially viable price for sterling.* The Journal noted: “The recent feverish state of the foreign exchange market has been succeeded by one of comparative calm.”403
A number of news items on August 8 contributed to the improved conditions. McAdoo scheduled his August 14 conference and released his agenda of “providing su cient ships to move our grain and cotton crops.”
Comptroller of the Currency Williams announced that banks had more than enough emergency currency to meet all depositor demands, freeing up gold for export.404 National City Bank announced its barter initiative, o ering a vehicle for agricultural exports should the foreign exchange market fail to revive. And a day earlier, J. P. Morgan arranged for a limited credit facility with its French a liate, Morgan Harjes & Company, restoring a semblance of commercial relations with Europe.405
Figure 5.2 focuses on foreign exchange in August. The value of the dollar increased as the price of sterling dropped to $4.95 two days before McAdoo’s conference of August 14. During the second half of the month the dollar gave up all of its gains: sterling rose above $5.05.
Why was the value of the American dollar so fickle?
McAdoo had analyzed the initial disruption in foreign exchange, and the resulting premium in the dollar price of sterling, with Max May, the Guaranty Trust Company’s foreign exchange expert. May had come to the capital to represent the views of New York foreign exchange dealers to McAdoo.406 May returned to New York on Sunday afternoon, accompanying McAdoo on his way to meet the bankers at the Vanderbilt Hotel.407 Although there is no record of their conversation, it might have gone something like this:
MCADOO: Why is the pound selling at such a ridiculously high price?
Doesn’t everyone know that Europe will need dollars to pay for the MAY:war? Supply and demand determine price, Mr. Secretary.
MCADOO: I’ve heard that before … tell me in your own words what it means.
MAY: Do you want me to go through the unpleasant details?
MCADOO: I’ve spent my life learning from the details.
Figure 5.2. Sterling Exchange Rate, August 1914.
Data Source: Wall Street Journal.
MAY: Okay, here goes. The supply of sterling in America comes primarily from exporters who receive British pounds, or, more precisely, claims to pounds in the form of a bill of exchange, in payment for goods shipped abroad. For example, an Arkansas farmer will draw a bill of exchange that obligates a London importer, actually the importer’s bank, to pay pounds for cotton.* Since American farmers want dollars to spend for more seed or for a night on the town, they sell those bills of exchange to a foreign exchange dealer like me. I pay the farmer in dollars for the bill of exchange at the going dollar price of pounds—
and that, of course, is the exchange rate. I buy bills of exchange
representing a claim on pounds because, just like any other merchant, I expect to quickly resell them at a small profit. But if farmers can’t
export their products to Britain I have no pounds to sell. Price jumps when supply dries up.
MCADOO: But we both know that’s only half the story. I thought by
closing the stock exchange I reduced the demand for pounds by British investors. They can no longer sell their U.S. securities on the New York Stock Exchange to get dollars and then demand pounds in exchange.
And without any demand for pounds by British investors, why should the price of sterling be so high?
MAY: Ah, but many British investors already liquidated their stocks and bonds before the exchange closed. British investors who sold on Thursday, July 30—and there were quite a few—had dollars and wanted pounds. Some foreign exchange dealers accommodated these customers by selling pounds to them without having first purchased
bills of exchange.* They were then short pounds.
MCADOO: Sounds like they were speculating—just like the accusations of some midwestern congressmen.
MAY: Only a little. Remember foreign exchange dealers can normally generate pounds even without bills of exchange. They could always take the dollars they received from British investors to the subtreasury, exchange them for gold and then ship the gold to England where they would be credited with pounds. And that, you recall, is how gold
shipments constrain the volatility of the exchange rate—by creating a supply of pounds to meet the demand. But dealers had no way to cover their obligations in sterling when it became impossible to transport gold across the Atlantic. And that is why the price of pounds
exploded.† MCADOO: Ships.
MAY: Excuse me?
MCADOO: No one cares about ships but that’s what we need—ships to carry our exports .
MAY: You couldn’t be more right, Mr. Secretary, especially since America will need more pounds over the next few weeks and months to pay maturing corporate and municipal bonds that are still held in Britain and France.
MCADOO: It’s seems like such a waste. Sending gold abroad to pay our debts knowing the British and French will just have to send it back to pay for our cotton. Why don’t they just hold on to dollars?
MAY: Gold and sterling rule the world. Dollars just don’t measure up as a means of international payment.
MCADOO: Perhaps we can do something about that.
Many people knew that American exports would force down the price of sterling and push up the value of the dollar as the war progressed. Sir George Paish, editor of the British financial weekly, the Statist, and adviser to the U.K.
Treasury, wrote on August 1, 1914: “From the standpoint of the immediate future, a great war in Europe probably would bring economic advantage to the people of the United States. It would enable them to sell their great crops at prices which would make them a much greater pro t than they would have realized had there been no war.”408
But before food could work its magic on the dollar, America had to make good on maturing debts in Europe. No one would want to hold dollars if the United States failed to meet its obligations. Paish had calculated that British investors held more than $3.3 billion in American corporate and municipal securities.409 At the outbreak of the war, no one knew how many of these securities matured in coming months. Corporate America—and their bankers
—would have to pay their debts either in gold or British pounds. And not everyone wanted to. In August 1914 the dollar price of sterling served as a barometer of American credibility.