Lords of Finance: 1929, the Great Depression, and the Bankers Who Broke the World (40 page)

In retrospect, Strong made the right decision in resisting the pressure from Miller and Hoover to tighten credit in late 1925 and 1926. In their enthusiasm to save the country from overspeculation, they had fallen into the first trap of financial officials dealing with complex markets—an excessive level of confidence in their own judgments. Miller, the academic economist, and Hoover, the engineer, were both insulated from doubt by
their ignorance of the way markets operate. In their zeal to burst a bubble that did not exist, they would have damaged the economy without any tangible benefit.

There is no better way to understand the stock market of those years than to return to the story of General Motors. Between 1925 and 1927 the profits of General Motors went up almost two and a half times. With earnings of almost $250 million a year, it overtook U.S. Steel to become the most profitable company in America. Though its stock price quadrupled in those two years, and by the middle of 1927 the company was valued at close to $2 billion, with a price-earnings ratio of less than 9, it was still considered to be reasonably priced.

What of Billy Durant? If General Motors was the emblematic story of the 1920s boom, its founder came to symbolize the other face of that frenetic decade. Although the company he had started had gone on to become the most successful corporation in America, he refused to look back after losing control of it for the second time in 1920. At his peak, he had been worth $100 million. In 1920, the roughly $40 million he received for his stock in General Motors had largely gone to pay off his personal loans, and he had emerged with barely a couple of million dollars.

He was, however, obsessed with the stock market. He formed a consortium of multimillionaires—many of whom were also from Detroit and had made their money in the automobile industry—to play the market. Within four years, he had rebuilt his fortune. By 1927, he was running a fund of over $1 billion, and had indirect control of another $2 to $3 billion that friends would invest alongside him. It was as if Bill Gates had been forced out of Microsoft, only to reappear on Wall Street as one of the largest hedge fund managers.

Central bankers can be likened to the Greek mythological character Sisyphus. He was condemned by the gods to roll a huge boulder up a steep hill, only to watch it roll down again and have to repeat the task for all
eternity. The men in charge of central banks seem to face a similar unfortunate fate—although not for eternity—of watching their successes dissolve in failure. Their goal is a strong economy and stable prices. This is, however, the very environment that breeds the sort of overoptimism and speculation that eventually ends up destabilizing the economy. In the United States during the second half of the 1920s, the destabilizing force was to be the soaring stock market. In Germany it was to be foreign borrowing.

By the beginning of 1927, Germany seemed to have fully recovered from the nightmare years of hyperinflation. Schacht was in a position of unassailable power at the Reichsbank. After the Dawes Plan, he had been appointed to a four-year term during which, by the new bank law, he enjoyed complete security of tenure and independence of the government. He had consolidated his position within the Reichsbank by getting rid of the old guard from the Von Havenstein era, who had opposed his appointment, and putting his own people in charge. Moreover, though a General Council consisting of six German bankers and seven foreigners was supposed to oversee him, it met only quarterly, leaving him to operate unhampered. As one senior German politician of the time remembered, he employed the “tactic of consulting everyone
⁴²¹
and then doing exactly what he pleases.”

By virtue of position and personality, he dominated most discussions of economic policy within Germany. The liberal economist Moritz Bonn, an adviser to the Reichsbank, wrote of Schacht in those years, “He looked upon the world
⁴²²
as Hjalmar Schacht’s particular oyster, and was very sensitive to public criticism. Having clashed with many strong and ambitious personalities in the German banking and business world, he was full of resentment against colleagues who had at some time outdistanced him. Once he arrived at the head of the central bank, he gloried in being their boss.”

To the public, Schacht remained “the Wizard,” the savior of the mark. The visit by Strong and Norman in June 1925, his own trip to the United States that fall, and his acceptance as the third member of the central
banking triumvirate running the world’s finances had enormously enhanced his prestige. In the three years since their first meeting, he had developed a very strong personal bond with Norman—they met five times in 1924, three times in 1925, and four times in 1926. Norman admitted that Schacht could be difficult to work with, that among his peculiarities was a love of publicity and the habit of making too many speeches. But it was “a joy to talk finance” with Schacht, he used to say. His admiration for the German was so great that Sir Robert Vansittart, later head of the British diplomatic service, complained that Norman was “infatuated by Dr. Schacht
⁴²³
.”

Strong, however, had not taken to Schacht to the same degree. “He is undoubtedly
⁴²⁴
an exceedingly vain man. This does not so much take the form of boastfulness as it does a certain naïve self assurance,” wrote the American. Nevertheless, he was impressed by the way Schacht handled the Reichsbank. “He runs his part of the show with an iron hand. He does it openly, frankly, and courageously, and seems to have the support of his Government but it certainly would not do in America. . . . He doesn’t gloss things over; he seems actually to relish the difficulties. . . .”

Power seemed to suit Schacht. The family had moved out of their villa in Zehlendorf into the official residence of the Reichsbank president on the top floor of its headquarters on Jägerstrasse. Financially he had little to worry about—his salary was the equivalent
⁴²⁵
of $50,000 and he drew a further $75,000 from the pension that he had wrung from the Danatbank. To show he had arrived, he bought a grand country house some forty miles north of Berlin, which had been the hunting lodge and estate of Count Friedrich Eulenberg.

When in town, the Schachts entertained frequently. With his “ugly clown mask
⁴²⁶
of a face, curiously alive and attractive,” Schacht, always sporting a big cigar and accompanied by his matronly wife, Luise, who kept a “vigilant watch"
⁴²⁷
on him—he was said to have a wandering eye—became something of a fixture on the social circuit. He had a pompous habit of wearing his culture conspicuously on his sleeve, which some found irritating, while others ridiculed him behind his back for his arriviste pretensions—one acquaintance remarked that "he dresses with the taste of a socially ambitious clerk.” Nevertheless, he was a popular guest, something of a catch celebrated for his “cutting and devastating humor
⁴²⁸
.” The Aga Khan remembered the Schacht of those years as one of the most charming of dinner companions, who could hold “a whole table enthralled
⁴²⁹
” with his sparkling conversation. Priding himself as something of a poet, he would compose amusing little pieces of doggerel to entertain his fellow guests.

Before the war, social life in Berlin had been especially stultifying. Under the oppressive hierarchy imposed by the Junker elite around the court, there had been little interaction between the various circles in the city. However, the overthrow of the old Prussian nobility and the destruction of the middle class by inflation had transformed Berlin into a rootless society of politicians and profiteers, former aristocrats and foreign diplomats. It would have been an arid soulless sort of place but for its demimonde of artists. With its past swept away, the city had an unhinged nervous energy, an edge to it, that no other city in Europe could match, and it had attracted the best of the European avant-garde: writers, painters, architects, musicians, and playwrights. William Shirer, the journalist who would chronicle the rise of Nazism, first came to Berlin during those years and was captivated. “Life seemed more free
⁴³⁰
, more modern and more exciting than in any place I had ever seen.”

But for all its “jewel-like sparkle
⁴³¹
,” the city was wrapped in an atmosphere of impending doom. Norman sensed it when visiting Schacht in late 1926: “You feel all the time
⁴³²
that politically as well as economically Germany is still not far from a precipice.” After the fiasco of the Beer Hall Putsch, most people treated Hitler as a laughingstock. Nevertheless, there were ominous undercurrents of the convulsions to come. On March 21, 1927, a band of six hundred Nazi brownshirt storm troopers of the
Sturmabteilung
, the SA, beat up a group of Communists in eastern Berlin and marched into the center of the city, attacking anyone on the Kurfürstendamm who looked Jewish. The city authorities responded by banning Nazi activity from Berlin for a year.

But the economy was booming. Over the three years since the mark
had been stabilized, output rose close to 50 percent and exports by over 75 percent. The GDP had surpassed its prewar level by a good 20 percent, unemployment was now at a modest 6 percent, and prices were steady. The recovery was reflected in the stock market
⁴³³
. During the hyperinflation, few people had believed that capitalism would even survive in Germany and equities had become dirt cheap, having fallen to less than 15 percent of their 1913 inflation-adjusted value—the whole of the Daimler-Benz motor company, for example, could have been bought for the price of 227 of its cars. By 1927, however, the market had quadrupled in value from its low point in 1922.

The Dawes Plan had been an enormous success. In fact it had worked almost too well. American bankers, assured under the plan of being repaid first ahead of reparations owed to France and Britain, had fallen over one another in their enthusiasm to lend to Germany. In the two years since the plan, $1.5 billion flowed into the country, giving Germany the $500 million due for reparations and still leaving it an enormous surplus of foreign cash. Some of this money had gone to finance the reconstruction of industry; but a very large amount had been taken up by the newly empowered states, cities, and municipalities of the budding democracy to build swimming pools, theaters, sports stadiums, and even opera houses. The zeal with which foreign bankers promoted their wares led to a great many imprudent investments and a lot of waste—one small town in Bavaria, having decided to borrow $125,000, was persuaded by its investment banks to increase the amount to $3 million.

With so much foreign money coming in, imports ballooned and the pressure on the government to lighten up on the austerity of 1924 and 1925 became irresistible. By 1926, the national government itself was back to running deficits. These were, however, modest—only $200 million, or less than 1.5 percent of GDP—compared to the giant shortfalls of the hyperinflation years, and financed as they were by hard currency from abroad, did not lead to inflation.

By every indication, Schacht, as one of the architects of this authentic economic miracle, should have been a happy man. Instead, he continued
to be obsessed with reparations. Even at the time of the Dawes Plan, he had never been fully convinced that Germany could or even should pay the amounts envisaged. Nevertheless, he had grudgingly supported the plan and the foreign loans that came with it. He had hoped that
⁴³⁴
as the credits from the United States built up and began to rival reparations as a claim on Germany’s foreign exchange, they would create a powerful lobby of American bankers, who would share a common interest with the German authorities in getting future payments to the Allies reduced.

But Germany was now borrowing too much abroad. Schacht worried that the foreign debt buildup was becoming so large that when the day came for it to be repaid, it would precipitate a gigantic payments crisis and national bankruptcy. It made no sense to him for Germany to be borrowing dollars to build wonderfully modern urban amenities, such as opera houses, which could never generate the foreign currency to repay the loans. Moreover, Germany was so awash with foreign capital, and was being driven by so conspicuous a boom, that it was getting progressively harder for him to argue that the republic could not afford to meet its reparations obligations. The artificial boom was giving everyone at home and abroad a false sense of prosperity—a “chimera,” as he called it.

His problem was that there was very little he could do about the situation. If he tried to tighten credit to curb the domestic boom, he would simply end up encouraging borrowers to look abroad for cheaper loans and thus exacerbate the already excessive foreign borrowing.

He was not a man to agonize too long over dilemmas. In many ways, for someone with the reputation of being a calculating opportunist, he was oddly impulsive. On Thursday, May 12, 1927, he made his move. The Reichsbank instructed every bank in Germany to cut its loans for stock trading by 25 percent immediately. The next day, nicknamed “Black Friday” by the Berlin press, stock prices fell by over 10 percent. Over the next six months, they would slide by another 20 percent.

By going after the stock speculators, Schacht was hoping to crack the atmosphere of overconfidence and curb inflows of foreign money into Germany. This proved to be a serious miscalculation. Even though stocks had
gone up a lot in the last five years, this represented a recovery from the brink of disaster. The market was by no means overpriced—in early 1927, its total capitalization was only around $7 billion, less than 50 percent of GDP, still only 60 percent of its prewar level. More important, German municipalities, which were immune to stock market fluctuations, kept on borrowing abroad. All that Schacht had achieved with this hasty maneuver was unnecessary damage to business confidence.

Having thus failed to dam the inflow of foreign loans with his broadside against the stock market, Schacht now began to talk about doing something dramatic over reparations. A New York Fed official, Pierre Jay, passing through Berlin in June 1927, remarked that Schacht did “not wish to have things seem too good
⁴³⁵
in Germany for fear that it will help the execution of the [Dawes] Plan,” and speculated that he might take some other action deliberately to undermine Germany’s fragile prosperity in order to prove that reparations were too burdensome. Parker Gilbert, the American agent-general for reparations, who was as close to Schacht as anyone, observed that he had begun “openly and actively working for a breakdown” of the Dawes agreement, and described him during this period as “changeable and moody
⁴³⁶
,” “temperamental and mercurial.”