Lords of Finance: 1929, the Great Depression, and the Bankers Who Broke the World (72 page)

The second group to blame were the leading central bankers of the era, in particular the four principal characters of this book, Montagu Norman, Benjamin Strong, Hjalmar Schacht, and Émile Moreau. Even though they, especially Schacht and Norman, spent much of the decade struggling to mitigate some of the worst political blunders behind reparations and war
debts, more than anyone else they were responsible for the second fundamental error of economic policy in the 1920s: the decision to take the world back onto the gold standard.

Gold supplies had not kept up with prices; and the distribution of gold bullion after the war was badly skewed, with much of it concentrated in the United States. The result was a dysfunctional gold standard that was unable to operate as smoothly and automatically as before the war. The problem of inadequate gold reserves was compounded when Europe went back to gold at exchange rates that were grossly misaligned, resulting in constant pressure on the Bank of England, the linchpin of the world’s financial system, and a destructive and petty feud between Britain and France that undermined international cooperation.

The quartet of central bankers did in fact succeed in keeping the world economy going but they were only able to do so by holding U.S. interest rates down and by keeping Germany afloat on borrowed money. It was a system that was bound to come to a crashing end. Indeed, it held the seeds of its own destruction. Eventually the policy of keeping U.S. interest rates low to shore up the international exchanges precipitated a bubble in the U.S. stock market. By 1927, the Fed was thus torn between two conflicting objectives: to keep propping up Europe or to control speculation on Wall Street. It tried to do both and achieved neither. Its attempts to curb speculation were too halfhearted to bring stocks back to earth but powerful enough to cause a collapse in lending to Germany, driving most of central Europe into depression and setting in train deflationary forces throughout the rest of the world. Eventually in the last week of October 1929, the bubble burst, plunging the United States into its own recession. The U.S. stock market bubble thus had a double effect. On the way up, it created a squeeze in international credit that drove Germany and other parts of the world into recession. And on the way down, it shook the U.S. economy.

The stresses and strains of trying to keep the limping gold standard going may have made some sort of financial shakeout inevitable. It was, however, not necessary for the crisis to metastasize into a worldwide catastrophe. European central bankers had been dealing with financial crises for
more than a century. They had long absorbed the lesson that while most of the time the economy works very well left in the care of the invisible hand, during panics, that hand seems to lose its grip. Markets, particularly financial markets, became unthinkingly fearful. To reestablish sanity and restore some sort of equilibrium in these circumstances required a very visible head to guide the invisible hand. In a word, it required leadership.

After 1929, responsibility for world monetary affairs ended up in the hands of a group of men who understood none of this, whose ideas about the economy were at best outmoded and at worst plain wrong. Strong died in 1928. His successor, George Harrison, tried his best to fill his shoes but did not have the personality or the stature to assume control. Instead, authority at the Fed shifted to a group of inexperienced and ill-informed timeservers, who believed that the economy would automatically return to an even keel, that there was nothing to be done to counteract deflationary forces except wait them out. They failed to fulfill even the most basic central banker’s responsibility: to act as lender of last resort and support the banking system at a time of panic.

Norman and Schacht both understood that a financial system in free-fall requires active central bank intervention. But their two central banks, the Bank of England and the Reichsbank, were both chronically short of gold and had no room for maneuver. As a consequence, for all of Norman’s enormous prestige and Schacht’s creativity, they were both hamstrung by the dictates of the gold standard and were forced to remain locked in with the United States, deflating as it did.

The only central banker outside the Fed with enough gold to act independently was Moreau at the Banque de France. But having stumbled inadvertently into a position of financial dominance, he seemed more intent on using France’s newfound strength for political rather than economic ends. And so what began as modest and corrective recessions in the United States and Germany were transformed by sheer folly and short-sightedness into a worldwide catastrophe.

In 1934, Yale economist Irving Fisher testified before a House committee that when Strong died, “his policies died with him
⁷⁷⁸
. I have always
believed, if he had lived, we would have had a different situation.” He was the first of many economists and historians to raise the tantalizing counterfactual that things would have turned out differently if Strong had lived. Though Strong was responsible for many of the errors surrounding the reestablishment of the gold standard, and for the easy money policy that led to the stock market bubble, there is little doubt that in early 1931 he would have acted more vigorously and with greater effect than his successor, George Harrison, to prevent the cascade of bank runs. Moreover, on the international front he was the only member of the quartet with the necessary combination of ability, brains, and vision but also the economic firepower of the Fed’s gigantic gold reserves behind him to have assumed the leadership of the world economy and taken steps to counteract the global deflation.

More than anything else, therefore, the Great Depression was caused by a failure of intellectual will, a lack of understanding about how the economy operated. No one struggled harder in the lead-up to the Great Depression and during it to make sense of the forces at work than Maynard Keynes. He believed that if only we could eliminate “muddled” thinking—one of his favorite expressions—in economic matters, then society could allow the management of its material welfare to take a backseat to what he thought were the central questions of existence, to the “problems of life
⁷⁷⁹
and of human relations, of creation, behavior and religion.” That is what he meant when in a speech toward the end of his life he declared that economists are the “trustees, not of civilization
⁷⁸⁰
, but of the possibility of civilization.” There is no greater testament of his legacy to that trusteeship than that in the sixty-odd years since he spoke those words, armed with his insights, the world has avoided an economic catastrophe such as overtook it in the years from 1929–33.

This book is inevitably full of figures—particularly financial figures—in a variety of currencies. To keep things simple and help the reader, I have converted amounts that would normally be expressed in other currencies (for example French francs or German marks) into U.S. dollars—except in those cases where the context clearly requires otherwise.

Understanding the significance of economic numbers from the 1920s and relating them to today’s dollars is not a straightforward exercise. Not only have prices risen enormously since then, but the United States and European economies have also grown gigantically.

Financial magnitudes that relate to an individual’s economic situation—say Hjalmar Schacht’s salary—are best translated by adjusting for changes in the cost of living. As a rule of thumb, to compensate for the effects of inflation, multiply by a factor of 12. Thus Benjamin Strong’s salary of $50,000 as governor of the New York Fed in the mid-1920s would be the equivalent today of $600,000. And Keynes’s nest egg of $2 million built up over a long career of speculating in financial markets would be the same as $24 million today.

By contrast, in order to grasp the true significance of sums of money that relate to the economic situation of whole countries, such as the size of war debts owed to the United States, it is most useful not simply to make allowances for changes in the cost of living, but instead to adjust for changes in the size of economies. To translate such figures into comparable 2008 magnitudes, multiply by factor of 200.

For example, the bill for German reparations was fixed in 1921 at $12 billion. A similar debt today would be $2.4 trillion.

^fn1
German GDP in the 1920s was $15 billion, one-sixth the size of the U.S. economy. By comparison, Mexico in 1994 had a GDP of $450 billion, a little more than one-eighteenth that of a U.S. economy then of $7.5 trillion.

I have been thinking about this book now for over a decade. In 1999,
Time
magazine featured a cover story entitled “The Committee to Save the World.” The cover depicted three men: Alan Greenspan, then chairman of the Federal Reserve Board; Robert Rubin, then secretary of the treasury; and Larry Summers, then deputy secretary of the treasury. The article described how close the world had come to an economic meltdown in 1997 and 1998—the big Asian economies of Korea, Thailand, and Indonesia had had to suspend payments on hundreds of billions of dollars of debt, Asian currencies had collapsed against the dollar, Russia had defaulted on its domestic debt, and the hedge fund, Long-Term Capital Management, had lost $4 billion of its investors’ capital, threatening the stability of the entire U.S financial system. The three “economist heroes,” as
Time
magazine called them, were able to avert a disaster by acting quickly and aggressively to commit billions of dollars in public funds to stem a panic of proportions not experienced since the 1930s.

While the crisis of 1997 and 1998 was being played out, I was a professional investment manager. In trying to understand the origins of that economic breakdown and the role of central bankers in the drama, I began reading about the history of past upheavals, and in particular about the greatest financial crisis of them all, that which began in 1929 and led to the Great Depression. I discovered that in the 1920s, there was another group of high financial officials, this one dubbed by the press the “Most Exclusive Club in the World,” which in its day also sought to manage the international financial system. But, instead of averting a catastrophe and saving the world, the committee from the 1920s ended up presiding over the
greatest collapse that the global economy had ever seen. This book is the result of that research.

My biggest debts are to Strobe Talbott and Brooke Shearer. Ever since I began serious work on the book in 2004, they have been mentors, promoters, counselors, and editors, painstakingly reading and commenting on each successive draft. I also owe an enormous debt to Timothy Dickinson. He too read and commented on various drafts. With his astounding knowledge of history and his prodigious memory for facts, quotes, and anecdotes, he has helped me to understand much better the wider social and political context in which the events described here took place.

I would also like to thank all those who helped in various ways in the researching and writing of this book: David Hensler, Peter Bergen, and Michael D’Amato, whom I press-ganged into reading various sections of the book; Derek Leebaert, who guided me through the ways and byways of embarking on such a venture; Lily Sykes, who was so creative in hunting down documents and old newspapers clippings from archives in France and Germany; Felix Koch, who assisted with translations from German; Sarah Millard, Hayley Wilding, and Ben White at the Bank of England, Joseph Komljenovich and Marja Vitti at the Federal Reserve Bank of New York and Fabrice Reuzé at the Banque de France for their help in tracking down letters, documents, and photographs in their collections; and Reva Narula and Jane Cavolina for so efficiently organizing the footnotes. In addition, thanks to those friends who have listened so patiently to me talk about this book and given their support and encouragement: Michael Beschloss, David and Katherine Bradley, Jessica and Bob Einhorn, Michael Greenfield, Philip and Belinda Haas, John Hauge, Margaret Hensler, Homi Kharas, Tom and Marilyn Block, Bahman and Roya Irvani, Robert and Mary Haft, Antoine van Agtmael, Vikram Mehta and Shahid Yusuf.

I would like to express my gratitude to Peregrine Worsthorne for spending an afternoon with me sharing his memories of his stepfather, Montagu Norman.

Over the years, including while researching this book, my whole family and I have benefited from the generosity of Richard and Oonagh
Wohanka, who have opened their various homes to us in London, Paris, and most inspiringly Cap d’Antibes—which makes an unlikely but important cameo appearance in this book. Another place in the south of France, Cap Ferrat, shows up in the story. It is therefore fitting that I thank Maryam and Vahid Allaghband. I had few more productive weeks of writing than the one I spent working from the terrace of their villa on Cap Ferrat overlooking the Mediterranean.

I discovered that becoming an author can be a lonely business. I am therefore grateful to all those who have given me an excuse to get away periodically from pouring over old biographies and newspaper articles from the 1920s. I especially want to thank my colleagues at The Rock Creek Group, Afsaneh Beschloss, Sudhir Krishnamurthy, and Siddarth Sudhir and Nick Rohatyn of The Rohatyn Group for allowing me to keep at least one foot in the world of investments.

I had the good fortune to persuade David Kuhn to take me on as a client. He has not simply been my agent but more than anyone else helped give substance to what was at the time only the germ of an idea. I would also like to thank Billy Kingsland.

I have also had the benefit of working with two great editors at Penguin. Scott Moyers provided me with his incisive comments and direction during the early stages and Vanessa Mobley helped shape the book into its final form. I must also thank Ann Godoff for taking a gamble on an unknown and unproven writer. Susan Johnson did a stellar job with the copy-editing while the whole team at Penguin, particularly Nicole Hughes and Beena Kamlani, shepherded the book through the production process with great efficiency.