Generator is smoking and I think cutout is bad. No charge or discharge on amp meter.
Ground the output from the generator to one of the screws on the outside of the generator. Do not run the car without the generator grounded. When you have the time, remove the generator and either test and repair it or take it to someone whom you can trust to do so. You will most likely need a rebuilt generator and a new cutout.
Two things can happen to a standard cutout. 1. The points stick and current from the battery goes into the generator when the engine is not running. This can cause wires to get hot and usually something such as the generator itself, or the ammeter melt down maybe the wire will melt down. 2. The cutout goes open and the generator tries to charge what what would be percieved as a dead battery so the generator puts out maximum charge and melts down. If you are lucky you might save the generator by re-soldering the armature windings. Most likely need to rewind the generator.
By the way, I didn't answer your question. Do not bypass the cutout it will cause #1 of the above.
Picture 1 before the ground/ bad cutout.
Picture 2 after the ground and in my description bypassing the cutout.
Have I done this correctly?
Yes. I would take the cutout off, ground to the same screw and wrap tape around the hot battery wire to eliminate any possibility of a short to ground if the points close some how or remove the wire from the terminal block.
be sure and take Mark's advice