Lords of Finance: 1929, the Great Depression, and the Bankers Who Broke the World (13 page)

Indeed, Caillaux made things
¹¹¹
even worse for himself during the war. With his characteristic bad judgment, he became embroiled in 1916 with a shady bunch of characters who were trying to negotiate a back-channel settlement with Germany. One of these, Paul Bolo-Pasha, a confidence trickster in the joint service of the Egyptian khedive and German intelligence, was arrested in 1917, tried, and shot for espionage. In the ensuing spy mania that seethed through France, Caillaux himself was accused of treason. Deprived of his parliamentary immunity, he was jailed in early 1918. He would finally be brought to trial before the Senate, sitting as a high court of justice, in 1920. Though acquitted of treason, a capital offense, he would be found guilty of “imprudent conversations” with the enemy and condemned to three years imprisonment; five years deprivation of civil rights; and a peculiarly French punishment,
interdiction de séjour
—banishment from Paris, a somewhat archaic penalty usually reserved for drug addicts, white slavers, and thugs.

Watching the tragic, almost comical, antics of his old leader, there must have been times when Moreau felt that he had been cursed in his choice of mentors. Though the Banque d’Algérie was called upon to play a modest role in financing the war effort—it supplied some $200 million in loans
to the government—this was small compared to the $4 billion provided by its larger and more prestigious sibling, the Banque de France. By 1919, Moreau had almost reconciled himself to serving out his time until retirement in the backwaters of the Banque d’Algérie.

Germany’s strategy for paying for its military effort was dominated by the absolute conviction of the men around the kaiser that the war would be short, that the Reich would prevail, and that it would then present the bill to the vanquished. The German government raised barely 10 percent of the $47 billion it spent on the war from taxes. And because Germany lacked Britain’s sophisticated financial market, France’s great reserve army of middle-class savers, or a rich ally across the ocean willing to lend it vast amounts of money, it had to resort to an unusually high degree of inflationary finance. Whereas during the war, money in circulation doubled in Britain and tripled in France, in Germany it went up fourfold.

The architects of this disastrous policy were paradoxically two of the most competent financial officials in all Europe: Karl Helfferich, the secretary of the Reich Treasury Office, the imperial German equivalent of minister of finance, and Rudolph von Havenstein, the aristocratic head of the Reichsbank. Helfferich, the most famous economist in Germany, was a professor who before the war had written one of the best works anywhere on monetary economics,
Das Geld
, which had been through six editions and had been translated into numerous languages, including Japanese.

Von Havenstein, a lawyer by training, did not have the same background but was universally acknowledged to be one of the most dedicated, upstanding, and loyal officials in the entire Reich. With his piercing eyes, long and luxuriant, well-waxed whiskers, and pointed beard, he looked like the impresario of a Victorian music hall. In fact, like his two predecessors as president of the Reichsbank, he was a typical product of the higher reaches of the imperial civil service. Born into the Prussian gentry in 1857, of a landowning family from Brandenburg, he studied law and became a
county court judge. In 1890, he joined the Prussian Finance Ministry and was appointed president of the Reichsbank in 1908.

Service to the kaiser was the cornerstone of Wilhelmine Germany and both men allowed themselves to be blinded by their loyalty to the emperor, all the easier in Hellferich’s case because he was an extreme right-wing nationalist and a fervent believer in the glorious destiny of the German people and the historic mission of their leader.

Von Havenstein was a civil servant of the old school and believed strongly in the paramount virtue of duty. As one banker wrote, “Obedience and subordination
¹¹²
[were] part of his flesh and blood.” While the Reichsbank was legally owned by private shareholders, Von Havenstein and all his top officials were responsible to a board comprised of politicians: the imperial chancellor and four members representing the federal German states. The structure had been put in place by the founder of the Reichsbank, Count Otto von Bismarck, a man who above all understood power. Aside from the accumulation of an enormous personal fortune, Bismarck showed little interest in economics. However, when the Reichsbank was being formed in 1871, his own private banker and confidant, Gershon Bleichröder, warned him that there would be occasions when political considerations would have to override purely economic judgments and at such times too independent a central bank would be a nuisance.

Thus, even though the German money supply ballooned during the war, and prices more than quadrupled—the inflation rate exceeded 40 percent a year—Von Havenstein became something of a national hero. He was showered with honors and decorations, immensely popular with the public, and the kaiser even affectionately nicknamed him with the engaging pun
der Geld Marschall,
the “Money General.”

DESPITE HIS BELIEF
that the war had been a mistake, Hjalmar Schacht threw himself into the war effort as energetically as most citizens of imperial Germany. He was severely shortsighted and thus exempted from military service. Convinced like everyone else
¹¹³
that German victory was
assured, only three weeks after the outbreak he was busy developing a plan for extracting reparations from France. It was a sign of how far off the mark even the most astute observers were to be about the costs of the war that Schacht came up with a working figure of $10 billion. Though ten times the amount France had paid after the Franco-Prussian war of 1870, this would turn out to be only a fifth of the eventual total costs of Germany’s war budget.

In October 1914, as the Western Front sank into stalemate, Schacht was offered a job on the staff of the Banking Commission overseeing the finances of occupied Belgium, which was run by the military administration. He soon discovered that he was temperamentally ill suited to the army. He found the rigid hierarchy, the narrowness of the military mind, and the self-importance of the professional officer caste oppressive.

He also seemed to have had an unusual talent for making enemies. Within a short period, he managed to antagonize his superior, Major Karl von Lumm, the banking commissioner, in civilian life a member of the Reichsbank directorate. Schacht, always acutely sensitive when it came to matters of status, asked to join the officers’ club then housed in the Brussels casino. Von Lumm, an old bachelor who had been part of the Bavarian reserve before the war and was very proud of his military credentials and uniform, refused, citing Schacht’s status as a civilian. Schacht disastrously went over Von Lumm’s head to General von der Goltz, the governor general of Occupied Belgium, whom he had known before the war. He was admitted to the club all right, but at the price of Major von Lumm’s enduring enmity.

As part of his duties, Schacht organized a system by which the German army, rather than simply commandeering whatever goods it needed, paid for its requisitions with a special occupation currency of “Belgian” francs, which, by design, Germans could buy at a highly favorable exchange rate.

Demand for the Belgian francs was extremely strong, and in February 1915 Schacht allowed the Dresdner Bank, his employer in civilian life, to purchase a large quantity. Von Lumm promptly accused him of having violated the civil service code of ethics and brought Schacht up before an
investigating committee. It concluded that while he had done nothing illegal or unethical, Schacht had attempted to cover up his involvement and had come close to perjury by giving “insincere replies to the questions
¹¹⁴
put to him; and when the insincerity was pointed out . . . he attempted to justify himself by a far-fetched explanation of his statements.” The matter eventually went up as far as the office of the secretary of state for the interior; Schacht was officially reprimanded and resigned from the Banking Commission rather than risk dismissal.

Von Lumm had undoubtedly made a mountain out of a molehill. But even Schacht
¹¹⁵
was to admit in private years later that while he had not lied during the inquiry, he
had
been highly evasive. The incident, clouded in mystery, would dog his reputation for many years. Rumors circulated that he had embezzled
¹¹⁶
large amounts of money or had personally profited from his access to state secrets.

After war service that had lasted barely nine months, Schacht returned to his banking career. Once again, his overweening ambition got the better of him. Back at the Dresdner Bank, he pressed too hard for promotion to the board, was rebuffed, and had no option but to resign. He moved on to become a director of the Nationalbank, a well-regarded, if sleepy, second-tier firm based in Berlin.

As for so many Germans, the war was a grim time for the Schacht family. He lost two of his brothers—Oluf, from disease, and William, the youngest, at the Battle of the Somme. Food was scarce—they had to grow their own vegetables and acquired a goat, which they learned to milk—and times were hard.

For the United States the war was a windfall. European demand for American materials and supplies soared, setting off an enormous boom. Though these purchases were partly financed by Britain’s and France’s borrowing some $2 billion a year within the United States, the net effect led to
massive influx of gold into America, swelling its bullion reserves from under $2 billion to $4 billion. Because of the operation of the gold standard, the influx of gold created an unusual expansion of credit and the U.S. money supply doubled.

During those first few years of its existence, the Federal Reserve System found itself overwhelmed. It was trying to build up its staff; it had no experience as an institution in monetary affairs, and being the product of countless political compromises, its charter was riddled with contradictions. Benjamin Strong, governor of the Federal Reserve Bank of New York, was quick to exploit the uncertainty about who was in charge. While the New York Fed, as it would come to be called, was on paper merely one among the twelve regional Federal Reserve Banks and theoretically under the supervision of the Federal Reserve Board in Washington, a body made up of political appointees, it was by a long way the largest of the reserve banks, and Strong, not a man to wait upon orders, made himself the chief pilot of the whole system. By virtue of his connections among New York bankers, his background as one of the original architects of the system, and most important, his personality, he came to dominate discussions of monetary and financial policy.

As more and more gold accumulated in the various Federal Reserve banks, Strong had two big fears. One was that at the end of the war, this gold would all pour back to Europe, radically destabilizing the U.S banking system. The other was that the gold would stay, potentially causing a shortage of reserves in Europe and threatening even greater inflation at home. In either case, he recognized that the Fed would be unable to handle the disruptions on its own and would have to coordinate its response with the European central banks. And so in February 1916, he decided to make a “scouting trip” to Europe.

As he arrived, the war, which had been going on for eighteen months, was about to enter its bloodiest year. The actual fighting in Western Europe was restricted to a narrow corridor through Belgium and eastern France, and life in London or Paris, while austere, was not especially
dangerous. Since the
Lusitania
had been torpedoed and sunk off the coast of Ireland the year before, drowning almost 1,200 people, 124 of them Americans, the State Department had been warning its citizens not to travel to Europe.

Strong went first to Paris to meet his counterparts at the Banque de France and then to London. It was during this visit to the Bank of England that he first met Norman. Coming from the same generation, they immediately struck up a friendship. Unlike many of his colleagues in the City, Norman, having lived in the United States for two years, liked and admired Americans and he invited Strong to Thorpe Lodge one evening for a quiet dinner. Though Strong was the governor of the New York Fed and Norman a mere adviser to the deputy governor, on his return to the United States in April, Strong started to correspond with Norman. Initially both saw it just as a way to exchange information and views on the narrower aspects of credit policy. But over the months, their letters gradually become less formal and more personal, particularly when Norman took great pains to look after Strong’s eldest son, Benjamin, a sophomore at Princeton, who had gone to Europe as a volunteer with the American Ambulance Service in May 1917, after the United States entered the war on the Allied side.

Meanwhile, after Strong returned to the United States from Europe in the summer of 1916, he was buffeted by a series of personal tragedies. His wife, Katharine, still only twenty-eight, left him, taking their two young daughters with her. She moved across the country to Santa Barbara. Their marriage had been on the rocks for a while. They were temperamentally unsuited to each other—he was gregarious and social, she shy and retiring—and their age difference too great. His father-in-law, Edmund Converse, had been against his taking the Fed job from the very beginning, dismissing it as a quasi-government position with no future, and relations between the two men had steadily deteriorated. Katharine for her part had found it difficult to adjust to their diminished financial circumstances. Strong hoped for many years that they might be reconciled and was deeply
hurt when in 1921 she filed for divorce without even consulting him. After the summer of 1916, they were never to meet again.

That same summer, as his marriage was falling apart, he also fell ill, developing a nagging cough that became progressively worse. He was soon bringing up blood and experiencing terrible chest pains. That June he was diagnosed with tuberculosis. Then commonly known as consumption, the highly contagious disease, caused by airborne bacteria that attack the membranes of the lungs, was then the most common cause of civilian deaths in both Europe and America, affecting people of all classes, often in the prime of life. Though the incidence of the disease had markedly declined before the war as the poorly ventilated tenements of industrial cities were replaced by better housing, the war had seen a minor resurgence of it in Europe. Strong is likely to have picked up the infection on his visit there.