Lords of Finance_ The Bankers Who Broke the World Part 17

Everyone wanted to know more about the mysterious "crack-brained" economist of whose theories Roosevelt had become so enamored. Much to the dismay of the publicity-shy Warren, his face appeared on the cover of Time Time magazine. Reporters finally managed to track down the elusive professor who had taken leave from Cornell; he was living at the Cosmos Club in Washington and worked from an office in the Commerce Building with an unlisted phone number. There were no files in the office-he carried all his research in his briefcase and slipped in and out of the White House through one of the side entrances. Anyone knocking at the door would be greeted with a cry, "Not in!" magazine. Reporters finally managed to track down the elusive professor who had taken leave from Cornell; he was living at the Cosmos Club in Washington and worked from an office in the Commerce Building with an unlisted phone number. There were no files in the office-he carried all his research in his briefcase and slipped in and out of the White House through one of the side entrances. Anyone knocking at the door would be greeted with a cry, "Not in!"

As the bridge between the government and the markets, it was Harrison at the New York Fed who actually had to buy the gold. Here was a man trained to believe that nothing was more sacrosanct than the value of the currency, a protege of one of the key architects of the postwar gold standard, being asked to weaken the dollar as an act of policy. It was, as one journalist put it, "like asking a sworn teetotaler to swallow a bottle of gin."

Harrison was by nature a diplomat. With Wall Street mocking the president for allowing currency policy to fall into the hands of an expert on chickenfeed, it required all his tact and diplomatic skills to act as the intermediary between the bankers and a White House that was breaking every monetary convention in the rule book. When Harrison first informed Norman of the new policy, the British central banker "hit the ceiling." "This is the most terrible thing that has happened. The whole world will be put into bankruptcy," he exclaimed. Roosevelt and Morgenthau both roared with laughter at the thought of "old pink whiskers"-Roosevelt's nickname for Norman-and the other "foreign bankers, with everyone of their hairs standing on end with horror."

During November and December 1933, Harrison and the president would talk on the telephone several times a week, sometimes several times a day. Though Harrison thought that Warren's ideas were complete bunk.u.m, he gradually found himself succ.u.mbing to Roosevelt's seductive charm, even becoming an honorary a.s.sociate member of the president's circle. And so while all the other hard-currency men who had come in with the new administration-Warburg, Sprague, Acheson, Moley-resigned or were fired, Harrison hung in there, convinced that if he went, Roosevelt might come up with some even more harebrained scheme; or even worse, that Congress would get into the act. And he feared the inflationists in Congress more than Roosevelt's predilection for wacky ideas.

THE THREE-MONTH interlude in which Roosevelt spent his breakfast hours managing the world's gold price represents one of the more bizarre episodes in the history of currency policy. It undermined the dignity of the office of president and diminished respect for him abroad. Even Maynard Keynes, who was in favor of managed currencies, dismissed the exercise as "the gold standard on the booze." But at least the dollar staggered in the right direction.

By the end of the year, Roosevelt had begun to tire of the game; and in January 1934 he agreed to stabilize gold at $35 to the ounce. The dollar had now been devalued by over 40 percent. And while the high priests of Wall Street had prophesied chaos, Roosevelt's instincts were vindicated. Devaluation changed the whole dynamic of the economy.

This worked in two ways. First, as Warren had predicted, the fall in the dollar did get prices moving upward-by roughly 10 percent per annum. Once prices began rising, the burden of interest payments and the real cost of money were automatically reduced, making businesses more willing to borrow and consumers more ready to spend. By thus shaking the country out of its funk, the dollar move reversed expectations out of their vicious and self-fulfilling downward spiral into a virtuous circle pointing the other way. For as the economy developed momentum, the recovery fed on itself.

Devaluation not only changed the dynamic of spending, it also supplied the fuel to power those expenditures. In the four years after 1933, the value of gold held by the Fed almost tripled, to $12 billion, in part due to the higher value of the existing stock of gold, in part to new inflows of gold from abroad-over $5 billion of additional bullion arrived in the country. Some of this was drawn from other central banks. But most came from the ground, as the higher price spurred the mining industry-worldwide gold production added almost $1 billion a year to world reserves. A high fraction of this additional liquidity went into building up the reserves of banks, which, scarred by the years from 1931 to 1933, took a long time to regain their nerve. Nevertheless, there was enough money flooding through the system that it percolated though to the rest of the economy.

As a consequence, during Roosevelt's first term, U.S. industrial production doubled and GDP expanded by 40 percent-the largest peacetime increase in economic activity in a presidential term. The expansion did not occur in a straight line and was not uniform. Confidence was still fragile and recovery thus subject to fits and starts. Investment did not rebound as much as consumption-for many of the New Deal policies to support wages hurt both profits and general business confidence. The economic indicator, which took the longest to recover, was employment. Even while production doubled in four years, the number of unemployed remained stubbornly high-by 1936, there were still ten million men without jobs. Again, many of Roosevelt's measures to boost prices or wages by government fiat raised the cost of hiring workers and hampered recovery. Because the contraction had gone so deep, it still took ten years for the economy to regain its old trend.

While the rebound was powered by an abundance of money at low interest rates, the Fed found itself ejected from the driving seat. Having made such a mess during the collapse, it had lost whatever prestige it once possessed.

In 1935, Congress pa.s.sed a banking act designed to reform the Federal Reserve. Authority for all major decisions was now centralized in a restructured Board of Governors. The regional reserve banks were stripped of much of their powers and responsibility for open market operations was now vested in a new committee of twelve, comprising the seven governors and a rotating group of five regional bank heads, renamed presidents. The secretary of the treasury and the comptroller of the currency were removed from the Board, giving it theoretically even greater independence from an administration. While these measures improved the efficiency of the Fed's decision-making machinery, they came ironically enough at a time when there were few decisions to take. In 1934, Marriner Eccles, a Mormon banker from Utah, had taken over as the head of the Federal Reserve Board. Scarred by the experiences of running a bank during the Great Depression, Eccles held to the view that with unemployment still high and confidence still weak, the Fed's prime task should be to keep interest rates as low as possible.

Though the New York Fed lost much of its clout and was now overshadowed by the Board in Washington, George Harrison soldiered on as its president for another eight years. In 1941, he left to become the chief executive the New York Life Insurance Company. During World War II, he was asked by his old friend Henry Stimson, now secretary of war, to become his special a.s.sistant for matters related to the Manhattan Project. He served on the Interim Committee, a secret high-level group formed in May 1945 to examine problems related to the creation of the atomic bomb and to advise on its use against j.a.pan. On July 16, after the successful detonation of the world's first nuclear device in the New Mexico desert, it was Harrison who was the author of the now-famous cable to Secretary Stimson and President Truman at Potsdam: "Operated on this morning. Diagnosis is not complete but results seem satisfactory and already exceed expectations."

After the war he returned to the New York Life Company. Like so many central bankers, he married late-at the age of fifty-three-to Mrs. Alice Grayson, widow of his old friend Admiral Grayson, who had been Woodrow Wilson's doctor and accompanied him to the Paris Peace Conference. Harrison died in 1958 at the age of seventy-one.

22. THE CARAVANS MOVE ON.

1933-44.

If a man will begin with certainties, he shall end in doubts; but if he will be content to begin with doubts, he shall end in certainties.

-FRANCIS BACON

BREAKING with the dead hand of the gold standard was the key to economic revival. Britain did so in 1931 and began its recovery that year. The United States followed in March 1933 and that proved to be the low point in its depression. France hung on to its link with gold for the longest. In 1935, Clement Moret was fired as governor of the Banque de France for resisting government measures to utilize its gold reserves to expand credit. Only in the following year did France finally abandon the gold standard. It was thus the last of the major economies to emerge from depression.

The exception to this pattern was Germany. After the summer 1931 crisis, it defaulted on reparations and introduced exchange controls. But it never officially left the gold standard. Still obsessed by an archaic fear of inflation, a carryover from 1923, and despite having no gold reserves, Germany decided to act as if it were still on gold, nailing itself to a sort of shadow standard and thereby forgoing the benefits of a cheap currency. x When Britain devalued the pound in September, German foreign trade completely collapsed.

Schacht with Adolf Hitler FIGURE 8.

The continued economic slide in 1932 precipitated even more political turmoil. In May 1932, Bruning was turned out of office by a right-wing cabal. The following month, France and Britain, finally recognizing that it was impossible to squeeze any money out of Germany in the current environment, formally agreed to forgive all reparations. In the fourteen years since these had first been imposed, the Allies, who had once demanded $32 billion, and had settled on $12 billion, had succeeded in collecting a grand total of $4 billion from their old enemy.

Bruning was replaced by Franz von Papen, an ex-cavalry officer from an impoverished aristocratic family who had married into wealth and whose only talent was his horsemanship. In August, he called new elections, in which the n.a.z.is won 230 seats, more than double their previous representation, making them the largest party in the Reichstag. But President Von Hindenburg was not yet ready to invite the "Bohemian Corporal," as he referred to Hitler, to become chancellor.

In 1931, Hjalmar Schacht had been interviewed by the American journalist Dorothy Thompson. "If Hitler comes to power, the n.a.z.is can't run the country financially, economically. Who will run it?" she asked. "I will," replied Schacht. "The n.a.z.is cannot rule, but I can and will rule through them." It had become clear to him even then that it was only a matter of time before Hitler would become chancellor.

Schacht would later claim that he never allowed himself to fall under Hitler's spell and that because Hitler needed him, he was able to maintain a certain degree of independence. This is not apparent in a creepy letter he wrote to Hitler after the August elections, congratulating him on his victory and regretting that he was not already chancellor: "Your movement is carried internally by so strong a truth and necessity that victory in one form or another cannot elude you for long. During the time of the rise of your movement you did not let yourself be led astray by false G.o.ds. . . . If you remain the man that you are the success cannot elude you for long." But the main purpose of the letter was to urge Hitler to avoid becoming entangled in economic ideology-for Schacht realized that if he wanted to run n.a.z.i economic policy, he would have to counteract some of the anticapitalist sloganeering of the party's left. At this stage he believed that its virulently anti-Semitic ragings were restricted to a lunatic fringe. He ended by saluting Hitler "with a vigorous Heil."

Over the next few months, as the n.a.z.is maneuvered to undermine successive governments in the Reichstag, Schacht became a prominent supporter of the movement and a major fund-raiser for the party. In November, he was one of twenty-tour industrialists, including the steel magnate Fritz Thyssen and the arms manufacturer Gustav Krupp, who signed a public letter urging Von Hindenburg to appoint Hitler chancellor. In an interview carried in newspapers around the world, Schacht declared that Hitler was "the only man fit for the Chancellorship." Finally, in January 1933, the president bowed to necessity and appointed the "Bohemian corporal" as chancellor.

Two months later, on March 16, 1933, Schacht was back at the Reichsbank, after a three-year hiatus. Hitler, who showed little interest in economics, had two overriding objectives-to combat unemployment and to find the money to rearm. The details of how to achieve these goals he left to Schacht, who in those early years was given almost complete control over economic policy-in addition to being president of the Reichsbank, he became minister of the economy in August 1934. Hitler would later confess that he thought Schacht "a man of quite astonishing ability . . . unsurpa.s.sed in the art of getting the better of the other party. But it was just his consummate skill in swindling other people which made him indispensable at the time."

Displaying the inventive genius that distinguished him as the most creative central banker of his era, immediately upon taking office, Schacht threw the whole baggage of orthodox economics overboard. He embarked on a ma.s.sive program of public works financed by borrowing from the central bank and printing money. It was a remarkable experiment in what would come to be known as Keynesian economics even before Maynard Keynes had fully elaborated his ideas. Over the next few years, as the German economy experienced an enormous injection of purchasing power, it underwent a remarkable rebound. Unemployment fell from 6 million at the end of 1932 to 1.5 million four years later. Industrial production doubled over the same period. Schacht also renegotiated the terms of Germany's ma.s.sive foreign debts, ruthlessly playing off its creditors against one other, particularly the British and the Americans.

The recovery was not quite the miracle that n.a.z.i propagandists made everyone believe it was. Though there were some highly visible achievements-the creation of millions of jobs, the construction of the famed autobahns-the boom remained stunted and lopsided. Much of the increase in production came in arms-related industries, such as autos, chemicals, steel, and aircraft, while such everyday consumer items as clothing, shoes, and furniture stagnated. As a consequence, the standard of living of ordinary Germans rose hardly at all. They had to content themselves with a drab existence of shoddy goods made of ersatz materials-sugar from sawdust, flour made with potato meal, gasoline distilled from wood, margarine from coal, and clothes made out of chemical fibers.

While other European countries let their currencies fall against gold, Schacht, motivated by a combination of concern for prestige and fear of inflation, refused to break officially from gold and devalue the Reichsmark. German goods were overpriced on the world markets and its exports stagnated. In order to cope with the pressures created by this bloated exchange rate, an elaborate system of import controls was put in place and foreign trade was largely based on barter. Under this "Schachtian" system, Germany was reoriented from an open economy integrated with the West to a closed autarkic economy connected to Eastern Europe and the Balkans, a precursor of the inefficient Soviet trade system of the 1950s and 1960s.

Behind the gleaming achievements, therefore-the autobahns, the Volkswagen, the Junker bombers, and the Messerschmitt fighter planes-the n.a.z.i economy was a rickety machine plagued by shortages and relying heavily on rationing to allocate scarce consumer goods.

Schacht, once such a strong believer in an open Germany integrated with the West, justified himself by arguing that he had been driven to the policy of hunkering down and looking inward by a deranged international system: "The whole modern world is crazy. The system of closed national boundaries is suicidal . . . everybody here is crazy. And so am I. Five years ago I would have said it would be impossible to make me so crazy. But I am compelled to be crazy."

When he first came to power, Schacht used to say that he would be willing to make a pact with the devil in order to restore German economic strength. By the late 1930s, he began to fear he had done just that. He never joined the n.a.z.i Party nor did he become a member of Hitler's inner circle. But as the regime's abuse of power mounted, he found himself increasingly at odds with the direction of those who ran it. He had always kept his distance from the other n.a.z.i bigwigs-Himmler, Goring, Goebbels- often treating them with contempt and relying on Hitler to protect him. Now he came into open conflict with them, especially over corruption.

On the Berlin c.o.c.ktail circuit the rumor was that Schacht had the banknotes issued to the ministries controlled by Goring, Goebbels, and Himmler marked, thus enabling him to track how much ended up in foreign accounts. He was increasingly heard referring to the n.a.z.is as a bunch of "criminals" and "gangsters," and even calling Hitler a "cheat and a crook."

Schacht was not above exploiting the popular irrational hatred and suspicion of Jews by peppering his speeches with anti-Semitic remarks. Nevertheless, he fought against many of the regime's more extreme policies against Jews not so much on moral grounds as out of the pragmatic fear that they were harming the economy. In 1938, he was one of the architects of a plan to allow four hundred thousand German Jews to emigrate over the coming three-year period, their a.s.sets to be expropriated and placed in a trust as collateral for bonds that were to be sold to rich Jews outside Germany. The money so raised was to be used to resettle German Jews and to subsidize German exports-a macabre extortionary scheme in effect to ransom these desperate people. It placed the international Jewish community in a quandary-whether to agree to a plan that implicitly sanctioned seizing Jewish property in Germany and Austria, channeling money to the n.a.z.i regime and setting a precedent for other blackmail elsewhere in Europe, but which had the potential to save lives. Schacht would later defend himself by claiming that his scheme could have saved hundreds of thousands of lives-he seemed conspicuously unaware of the moral dilemmas it posed. In any case, it died for lack of money and of countries willing to accept the refugees.

By 1937, the strains of helter-skelter rearmament and deficit financing began to tell. Shortages began to bite. Schacht tried to push Hitler to go slow on the arms buildup and ease up on consumer austerity. In November 1937, after falling out with Hermann Goring, he was fired by Hitler as minister of the economy and replaced by Walter Funk, an alcoholic h.o.m.os.e.xual. Two years later, when Schacht tried to resist further central bank financing of the ever-growing budget deficit, he was also removed from the Reichsbank, again to be replaced by Funk. Though Hitler gave him the t.i.tular position of minister without portfolio, this was largely window dressing for foreigners-Schacht was still respected by the international banking community-and he was now for all intents and purposes a private citizen.

In the years immediately before the war, Schacht took a leading part in several of the conspiracies by conservative politicians and businessmen to overthrow Hitler. They involved trying to induce members of the army high command to stage a coup by convincing them that under the n.a.z.is, Germany would be plunged into a war for which it was ill prepared. The first took place in 1938 when Hitler tried to take over Czechoslovakia. Plans for that pustch were aborted at the last minute when British prime minister Neville Chamberlain and French premier edouard Daladier backed away from the brink by making concessions at Munich. A second occurred in late 1939 in the weeks before the invasion of Poland. This final conspiracy was overtaken by events before the plotters could act.

After war broke out, Schacht kept a low profile, retiring to his estate in Guhlen away from the intrigue and paranoia of Berlin. It was ironically a time of great personal happiness. His first wife died in 1940. They had become estranged over time and lived apart. The following year, at the age of sixty-four, he married a woman thirty years his junior, a museum curator whom he had met at a fashionable Munich nightclub. Over the next three years, they had two children, both girls.

Though Schacht remained on the fringes of the resistance movement, he was never trusted enough to be included in the inner circles. But his name was frequently mooted as a potential successor to Hitler in the event of a coup. In April 1944, his son-in-law Hilger von Scherpenberg, a German foreign service officer based in Stockholm, was arrested by the Gestapo. Following the failed July 20 plot to a.s.sa.s.sinate Hitler, Schacht was also arrested and imprisoned in Berlin-not because of any evidence of his complicity but because of his potential usefulness as a hostage or an intermediary in future negotiations with the Allies. In April 1945, he was sent to Dachau. Two weeks later, as the Allied armies advanced into Germany, he was one of a group of high-value prisoners, including Prince Philip of Hesse: the French ex-prime minister Leon Blum and his wife; General Franz Halder, formerly chief of the army staff, and his wife; Fritz Thyssen, the steel baron; and Prince Frederick Leopold of Prussia, who were shipped out-to be traded as potential hostages. They were finally liberated by the Allies from a camp in the southern Tyrol.

Instead of greeting Schacht as a hero, the Americans arrested him, and he was among the twenty-four major figures to be prosecuted at Nuremberg. Furious at being lumped in with the "gangsters" of the n.a.z.i regime, he insisted that he was different, that he had acted only in self-defense to protect Germany against the Allied economic stranglehold and had broken with the fuhrer once he realized war was inevitable. A prison psychologist describes Schacht losing his temper one day and ranting, "Don't forget what desperate straits the Allies drove us into. They hemmed us in from all sides-they fairly strangled us! Just try to imagine what a cultured people like the Germans has to go through to fall for a demagogue like Hitler. . . . All we wanted was some possibility for export, for trade, to live somehow. . . ."

In the lead-up to the trial, each of the defendants was subject to extensive interrogation, a battery of psychiatric interviews, and even an intelligence test-Schacht achieving the highest score, 143. During the ensuing trial, he found it hard to disguise his fury. The novelist John Dos Pa.s.sos described him as glaring "like an angry walrus" during the whole proceedings. Rebecca West wrote that he sat "twisted in his seat so that his tall body, stiff as a plank, was propped against the side of the dock. Thus he sat at right angles to his fellow defendants and looked past them and over their heads: it was always his argument that he was far superior to Hitler's gang. He was petrified by rage because this court was pretending to have this right. He might have been a corpse frozen by rigor mortis. . . ."

Schacht and Von Papen were acquitted, on the grounds that their involvement with the n.a.z.i regime had ended before war broke out. Three days after being released, he was rearrested by the new government of the State of Bavaria under its de-n.a.z.ification laws. After five different trials, all of which ended without a conviction, he was finally released in 1950.

In the last few days of the war, his only son, Jens, had been captured by the Russians and was never heard of again, one of the countless German soldiers who disappeared in the death march of prisoners on the Eastern front. Dest.i.tute at the age of seventy-three, Schacht started a new life and a new career as an independent economic consultant and became an adviser to the governments of Indonesia, Egypt, and Iran. He died, substantially prosperous, in 1970, aged ninety-three. To the end he refused to concede that he had ever done anything wrong.

THE WAR MADE for strange bedfellows. The other member of the quartet, emile Moreau, had become president of the Banque de Paris et des Pay-Bas after retiring as governor of the Banque de France in October 1930. In 1940, after the fall of France and the German occupation, Moreau was forced out by the Vichy regime for being too sympathetic to Britain-the ultimate irony for a man who at the peak of his career had done his best to undermine British dominance in finance.

Horrified at the social and ideological conflicts by which France was riven in the 1930s, Moreau became progressively more disillusioned with French republican politics and parliamentary democracy. He could not support the left, and the right was becoming more fascist by the day. Instead, he became a royalist-a quixotic commitment. Royalists were a fringe group-one poll found less than 6 percent of the French believed that the monarchy had any role whatever to play in the politics of the country.

In 1935, he took on the position of secretary to the pretender to the throne, Jean d'Orleans, duc de Guise, great-grandson of Louis Philippe, the liberally inclined king of France from 1830 to 1848. The law of exile pa.s.sed in 1886 prohibited the heirs of former French dynasties from entering France, and Moreau acted as the duke's liaison in France. In 1940, when Jean d'Orleans died, his son Henri, comte de Paris, succeeded as pretender. After the fall of France that year, Henri tried to provide a bridge between the Free French and the collaborators at Vichy and for a brief moment there was even talk that the monarchy might return. Though Moreau did his best to promote the idea, nothing came of it and the comte de Paris returned to his place on the social pages of Paris Match. Paris Match.

In 1950, the law of exile was finally repealed and the comte de Paris was allowed back to France. Moreau lived long enough to receive his beloved sovereign at his home in Paris, which subsequently became the secretariat for the comte's activities. Moreau died that November.

WHILE HJALMAR SCHACHT was propelled back into power during the 1930s, his friend Montagu Norman had to content himself with a much diminished role in British and international financial affairs. In October 1933, he crowned his annual Mansion House speech by quoting an old Arab proverb: "I console myself with this thought, that the dogs bark but the caravan moves on." In the old days it would have been viewed as one of those enigmatic Zen-like p.r.o.nouncements that evidenced the governor's superior wisdom. Instead, it now provoked an outcry. The implication that his critics were no more than barking dogs unleashed a torrent of indignation directed against the entire banking and financial establishment. "They were wrong about reparations from Germany and its effects. They were wrong when they advised Mr. Churchill about the gold standard, and wrong when they pled in 1931 that the resuspension of the standard would knock the bottom out of civilization." He was increasingly viewed as an "old gentleman complaining that things were not what they were." Despite all this, he was reappointed governor for an additional eleven years-perhaps because with his authority so diminished there was little damage he could do.

In the late 1930s, he became a.s.sociated with the party of appeas.e.m.e.nt. Though he was not part of the whole Cliveden set around Nancy Astor, finding the whole atmosphere of political gossip and scandal distasteful, he shared their belief that another war would just be too catastrophic to contemplate and was willing to do almost anything to avoid it. Appeas.e.m.e.nt was still then a respectable word-it had not yet come to imply cowardice or self-deception. Indeed, it was considered to be not simply a pragmatic policy but a moral one as well. In the wake of the carnage of the First World War, pacifism was much in vogue, and German anger and bitterness at the Treaty of Versailles were viewed as justified. In Norman's case this was reinforced by his preference for the diligent Germans over the treacherous French and for his admiration of Schacht, and during the early years of n.a.z.i rule, even the achievements of Hitler-he is said to have told a Morgan partner that "Hitler and Schacht are the bulwarks of civilization in Germany."

In the last months of 1939, as war seemed increasingly likely, he lamented to the U.S. amba.s.sador in London, Joseph Kennedy, "If this struggle goes on, England as we have known her is through. . . . Without gold or foreign a.s.sets, England's trade is going to be forced to narrow itself more and more. . . . The end is likely to be that . . . the Empire will contract in power and size to that of other nations."

During the 1930s, he and Schacht maintained their close friendship-they would meet regularly at the monthly BIS meetings in Basel. In January 1939, he visited Berlin to attend the christening of Schacht's grandson, who was named Norman in his honor. The Foreign Office tried to convince him that, in the circ.u.mstances, such a visit was undesirable, but Norman insisted on going. It was to be their last meeting. Once their two countries were at war, they could not communicate, though there were constant rumors even in official circles that they stayed in touch. After the war, while Schacht was in prison, Norman sent him food parcels. But when the German tried to come to Britain in 1950 to visit his old friend, he was denied a visa.

In 1944, during a bad fog, Norman tripped over a large granite stone at his country cottage, and after grazing his leg, developed an infection that spread to his brain. Though he recovered after an operation, his health was now seriously impaired and he was finally persuaded at the age of seventy-three to retire as governor. He was elevated to the peerage that year as Lord Norman of St. Clere, the name of the village in Kent where his grandfather's house was located and which he had inherited from his uncle. He spent most of his last years there as an invalid. He died in 1950.

Norman himself provided the most poignant a.s.sessment of his own career. In 1948, he wrote: "As I look back, it now seems that, with all the thought and work and good intentions, which we provided, we achieved absolutely nothing . . . nothing that I did, and very little that old Ben did, internationally produced any good effect-or indeed any effect at all except that we collected money from a lot of poor devils and gave it over to the four winds."

AFTER 1931, As Norman's star fell, that of Maynard Keynes rose. Before the breakup of the gold standard Keynes had been the maverick. After the rupture he was increasingly acknowledged to have been right not simply about the gold standard but about almost every one of the battles in which he had been engaged during the previous decade. German reparations had now been canceled; France and Britain had defaulted on war debts; and the two major central banks, the Bank of England and the Fed, had embraced a policy of keeping money deliberately cheap.

With the world economy still stuck in the Depression, Keynes took a step back from public life and began work on a new theoretical book-an attempt to understand the causes of ma.s.s unemployment. Some of the driving forces behind the Depression, such as the collapse in Germany, could be explained by country-specific factors, for example, reparations and the overhang of foreign debt. But the United States had suffered none of these problems-it was a creditor country and had ample gold reserves. That it too had been hit by a downturn as deep, in some respects deeper, as that in Europe remained a mystery. Keynes wanted to understand how an economy could get stuck in such a severe slump and what might prevent conventional corrective forces-cuts in interest rates, for example-from working.

He drew on many of the same themes that had informed much of his previous work-the pervasive effects of uncertainty, the ways in which the financial system could short-circuit the normal operations of the economy, the inherent instability caused by fluctuations in confidence. The book was not completed until late 1935, and was published, in February 1936, as The General Theory of Employment, Interest, and Money. The General Theory of Employment, Interest, and Money. By the time it came out, Britain, the United States, and Germany were all on the road to recovery and the book itself did not have much impact on immediate government policy. Nevertheless, it was to be Keynes's masterpiece. While it was not universally accepted and indeed remained bitterly disputed for many years, it transformed the understanding of the modern monetary economy and still today provides the foundation for much of the government and central banks' management of the system. By the time it came out, Britain, the United States, and Germany were all on the road to recovery and the book itself did not have much impact on immediate government policy. Nevertheless, it was to be Keynes's masterpiece. While it was not universally accepted and indeed remained bitterly disputed for many years, it transformed the understanding of the modern monetary economy and still today provides the foundation for much of the government and central banks' management of the system.

A year after The General Theory The General Theory was published, in the spring of 1937, Keynes suffered the first of his many "heart attacks." He was diagnosed with a chronic cardiac condition caused by a bacterial infection of the heart valves. For the next three years he was almost an invalid. In 1939, he fell into the hands of a Dr. Janos Plesch, a Hungarian Jewish emigre, who, according to Keynes, was a cross between a "genius" and a "quack." In addition to some highly unorthodox protocols-three-hour sessions of ice packs placed on the chest or Dr. Plesch jumping up and down on his patient as he lay in bed-the doctor put Keynes on a course of the newly discovered and much in vogue sulfa drugs, the first and only effective antibiotic in the years before the large-scale use of penicillin. Though his heart condition was not completely cured, under the care of the eccentric Dr. Plesch-whom Lydia nicknamed "The Ogre"-Keynes was at least able to return to work. was published, in the spring of 1937, Keynes suffered the first of his many "heart attacks." He was diagnosed with a chronic cardiac condition caused by a bacterial infection of the heart valves. For the next three years he was almost an invalid. In 1939, he fell into the hands of a Dr. Janos Plesch, a Hungarian Jewish emigre, who, according to Keynes, was a cross between a "genius" and a "quack." In addition to some highly unorthodox protocols-three-hour sessions of ice packs placed on the chest or Dr. Plesch jumping up and down on his patient as he lay in bed-the doctor put Keynes on a course of the newly discovered and much in vogue sulfa drugs, the first and only effective antibiotic in the years before the large-scale use of penicillin. Though his heart condition was not completely cured, under the care of the eccentric Dr. Plesch-whom Lydia nicknamed "The Ogre"-Keynes was at least able to return to work.

During the 1930s, Keynes's speculative activities made him a rich man. After losing 80 percent of his money when commodity prices collapsed after 1928, he had ended 1929 with a portfolio of under $40,000. He shifted his strategy from short-term speculation to long-term investment and at the lows of the Depression put together a concentrated portfolio of a select number of British and American equities. Convinced that Roosevelt would succeed in reviving the U.S. economy, Keynes used margin to leverage his portfolio by as much as two to one. By 1936, his net worth was close to $2.5 million-the equivalent today of $30 million. Though the bear market of 1937 more than halved this, by 1943 it had recovered to $2 million.

By the late 1930s, Keynes was the most famous economist in the world and a pillar of the British establishment. He was elevated to the peerage in 1941, as Lord Keynes of Tilton, and much to the amus.e.m.e.nt of his bohemian Bloomsbury friends, was to be found regularly in attendance at the House of Lords. He was even invited to be a director of the Bank of England by his old opponent, Montagu Norman. While they continued to disagree-"I do enjoy these lunches at the Bank: Montagu Norman, always absolutely charming, always absolutely wrong," he remarked after one of his regular weekly meetings-it was now Keynes's ideas that were in the ascendancy.

When the Second World War broke out in Europe, Keynes became an unpaid economic adviser to the chancellor of the exchequer. Within a short time he was Britain's princ.i.p.al wartime economic strategist. Determined to avoid a repeat of the mistakes of the First World War, which had largely been financed by printing money, Keynes designed the framework for paying for this war without as much recourse to inflation. He also acted as the princ.i.p.al negotiator for Britain with the Americans over the scope, terms, and conditions of Lend-Lease.

In 1942, he turned his attention to planning for the postwar world. After the First World War, central bankers had tried to re-create the golden age before 1914, to which they looked back so nostalgically. Keynes, in putting together his plan for a new international monetary system, had no such illusions-no one, least of all him, looked back except with horror to the chaos of the twenties and thirties.

In developing his ideas for the postwar world, Keynes sought to create an international financial system based like the gold standard on rules while tempering its rigidity. His plan called for currencies to be "pegged but adjustable." In contrast to the gold standard, under which currency values were supposed to be immutable fixed points, countries would be allowed to alter the value of their currencies when their economic circ.u.mstances changed. He was determined to avoid the need for the sort of straitjacket policies of the twenties and thirties when Germany and Britain had been forced to hike interest rates and create ma.s.s unemployment to protect currency values that were in any case unsuitable.

A second element of the plan was an international central bank. In order to avoid the chronic shortage of gold reserves that had prevented the global financial system from functioning smoothly between the wars, Keynes proposed creating an inst.i.tution that would lend money to countries in need on a temporary basis, rather like an overdraft facility at a bank.

Luckily for Keynes, the Americans began working independently on a similar conception. The architect of the U.S. plan was Harry Dexter White, the a.s.sistant secretary for international affairs at the U.S. Treasury. White had been born in Boston in 1892 of Lithuanian parents who had fled the czarist pogroms. Educated at Stanford and Harvard, he had eventually joined the Treasury in 1934 as a New Dealer and enjoyed a meteoric rise within the department through a combination of hard work, intelligence, and flattery in the right places.

Short and stocky with a round face, rimless gla.s.ses, and fleshy lips topped by a trim mustache, White was an unprepossessing man with few friends. He seemed unable to resist being overbearing and rude in his professional dealings, even to his colleagues, and he has variously been described by those who knew him as "the unpleasantest man in Washington," "a son-of-a b.i.t.c.h," and "an intolerable human being." Keynes, who was remarkably able to put up with people's foibles and idiosyncrasies, wrote that "he has not the faintest conception of how to behave or observe the rules of civilized discourse." But even though White was often overtly anti-British, Keynes grew to develop great respect for his incisive intelligence, his single-mindedness, and his drive.

White also happened to be a Soviet agent, originally recruited in 1935 to the same spy ring that included Whittaker Chambers and Alger Hiss. During the war, along with several colleagues at the Treasury's Division of Monetary Research, whom he talked into the cause, he did much to support the Soviet war effort and beyond. As the princ.i.p.al Treasury representative on interagency committees dealing with international affairs, White handled more pieces of cla.s.sified information than any other single official in the administration, including the president, and pa.s.sed on secrets about the whole range of U.S. financial policies to Soviet intelligence, including U.S. strategy on financial aid to the USSR. He helped the Communist cause in China by delaying payments of American aid to Chiang Kai-shek, and arranged for the U.S. government to furnish the Soviets with a duplicate set of printing plates of the currency to be issued under the Allied occupation of Germany-thereby allowing the Soviets to finance their share by printing American money with American-supplied plates. When these activities eventually came to light after the war, he insisted that he had not been a Soviet agent-he was neither a member of the Communist Party nor had he accepted any money from the Soviets-but had only been acting in the best interests of the United States, believing that the United States and the Soviet Union, allies at that time, had closely aligned objectives. But in 1942, no one was yet aware of White's secret life.

As originally conceived, the British and American plans did differ in emphasis. Keynes's plan was more ambitious in size and scope. Remembering the acute lack of liquidity during the 1920s, he wanted something closer to a world central bank with the power to create an international currency; White wanted an inst.i.tution more like an international credit cooperative that would give countries access to loans, the size of which would be constrained by the amounts paid in by the other member countries. Keynes wanted the fund to be $26 billion, while White, conscious that the United States would be paying much of the bill, wanted to limit it to $5 billion; they finally compromised on $8.5 billion. Keynes also wanted to introduce a mechanism for disciplining countries that unfairly cheapened their currencies and acc.u.mulated excessive amounts of the world's reserves without recycling them, as France had done in the twenties and thirties. But the United States, fearing that in the aftermath of the war it might find itself flooded with gold, and thus be accused of underpricing its currency, would not agree.

After two years of negotiations between Keynes and White, the differences were ironed out-largely in favor of the more powerful Americans. By 1944, with much of the design work done and with the two princ.i.p.al Western Allies in a position to present a united front, the United States felt ready to invite some forty-four countries to a conference to discuss reconstructing the postwar international monetary system.

The United States chose to host the gathering at the Mount Washington Hotel at Bretton Woods in the White Mountains of New Hampshire. With its rural seclusion, mild summer weather, and cool high-country air, it was a perfect site for such a meeting. Built in 1902 to cater to rich Bostonians and New Yorkers escaping the summer heat of the East Coast, the hotel looked like a great Spanish castle, with white stucco walls, two large castellated turrets, and a red roof. The interior was decorated in a rich Victorian style with Tiffany stained-gla.s.s windows. Though the hotel had fallen upon hard times in the 1930s, a victim of the Depression, it had recently been bought and refurbished by a syndicate of Boston-based investors. Moreover, unlike most large hotels in the White Mountains, which did not allow Jews-inconvenient for a conference hosted by Treasury Secretary Morgenthau, himself Jewish-the Mount Washington had no such restrictions on guests.

The conference opened on June 30, 1944. In contrast to the many international summits of the interwar period, which had been characterized by a corrosive atmosphere of mistrust, Bretton Woods was a collegial, almost jovial, affair. "The flow of alcohol is appalling," wrote Keynes. With 750 delegates, and even more a.s.sistants, it was, according to Lydia Keynes, a "madhouse with most people . . . working more than humanly possible." Committees met all day, broke for evening c.o.c.ktails and rounds of dinner parties, reconvening thereafter till 3:00 a.m., only to resume at 9:30 the next morning.

By the time of the Bretton Woods conference, Keynes's wartime efforts had taken a severe toll on his health. The drugs, which Plesch had prescribed, had not cured the bacterial infections in his heart, and he was now seriously sick. Lydia forbade Keynes to attend the c.o.c.ktail parties and required him to take his dinner with her in their suite. Nevertheless, she contributed her own part to the madhouse atmosphere by doing ballet exercises late at night in her room and keeping other guests awake, including Mrs. Morgenthau in the suite below.

Much of the negotiating had been done prior to the conference between the Americans and the British. At Bretton Woods, the biggest controversy was over how much money each country would be eligible to borrow from what was now being called the International Monetary Fund. The Russians, who were there in strength though very few of them spoke English, demanded that their borrowing rights reflect not simply economic power but also military strength, and insisted on equality with the British; India wanted to be on a par with China; the Bolivians wanted parity with the Chileans and the Chileans with the Cubans. The United States, as the fund's prime financier, set these quotas in a series of back-room deals orchestrated by White.

On July 22, the conference came to its formal close with a great banquet. Keynes gave a final address. He reminding the partic.i.p.ants of the economic chaos that had afflicted the world for almost a generation and paid tribute to the spirit of cooperation that had informed the discussions: "If we can so continue, this nightmare, in which most of us present have spent too much of our lives, will be over. The brotherhood of man will have become more than a phrase." As he left the room, the delegates sang "For He's a Jolly Good Fellow."

Two years later, Keynes's heart finally gave out and he died at the age of sixty-one. White was appointed the U.S. executive director of the International Monetary Fund after the war, but in 1947, under investigation by the FBI, he was forced to resign, citing ill health. The next year, after being publicly named as a Soviet agent by Whittaker Chambers, he was called to testify before the House Committee on Un-American Activities. Three days after his testimony, on August 16, 1948, he, too, collapsed and died of a heart attack at the age of fifty-six.

Nevertheless, the legacy of these two men, the international monetary arrangements known as the Bretton Woods System, fruitfully endured for another thirty years. It provided the foundations for the reconstruction of Europe and j.a.pan after the war, it allowed the global economy to boom through much of the 1950s and 1960s without any of the financial crises that had been so much a part of its history, and it set the stage for one of the longest periods of sustained economic growth the world has ever seen.

23. EPILOGUE.

I have yet to see any problem, however complicated, which, when looked at in the right way did not become still more complicated.

-Poul ANDERSON

ANYONE who writes or thinks about the Great Depression cannot avoid the question: Could it happen again? First it is important to remember the scale of the economic meltdown that occurred in 1929 to 1933. During a three-year period, real GDP in the major economies fell by over 25 percent, a quarter of the adult male population was thrown out of work, commodity prices fell in half, consumer prices declined by 30 percent, wages were cut by a third. Bank credit in the United States shrank by 40 percent and in many countries the whole banking system collapsed. Almost every major sovereign debtor among developing countries and in Central and Eastern Europe defaulted, including Germany, the third largest economy in the world. The economic turmoil created hardships in every corner of the globe, from the prairies of Canada to the teeming cities of Asia, from the industrial heartland of America to the smallest village in India. No other period of peace time economic turmoil since has even come close to approaching the depth and breadth of that cataclysm.

Part of the reason for the extent of the world economic collapse of 1929 to 1933 was that it was not just one crisis but, as I describe, a sequence of crises, ricocheting from one side of the Atlantic to the other, each one feeding off the ones before, starting with the contraction in the German economy that began in 1928, the Great Crash on Wall Street in 1929, the serial bank panics that affected the United States from the end of 1930, and the unraveling of European finances in the summer of 1931. Each of these episodes has an a.n.a.logue to a contemporary crisis.

The first shock-the sudden halt in the flow of American capital to Europe in 1928 which tipped Germany into recession-has its counterpart in the Mexican peso crisis of 1994. During the early 1990s, Mexico, much like Germany in the 1920s, allowed itself to borrow too much short-term money. When U.S. interest rates rose sharply in 1994, Mexico, like Germany in 1929, found it progressively harder to roll over its loans and was confronted with a similar choice between deflation or default.

There are, of course, differences. Germany in 1928 was much larger compared to the world economy-about three times the relative economic size of Mexico in 1994.51 But the biggest difference was to be found in the management of the crisis. The U.S. Treasury under Secretary Robert Rubin forestalled a default by providing Mexico an emergency credit of $50 billion with astonishing rapidity. Germany in 1929 had no such savior. Moreover, in 1994, Mexico could devalue the peso. In 1929, having only just emerged from a terrible bout of hyperinflation, Germany felt bound by gold-standard rules and sacrificed its economy to maintain the parity of the Reichsmark. But the biggest difference was to be found in the management of the crisis. The U.S. Treasury under Secretary Robert Rubin forestalled a default by providing Mexico an emergency credit of $50 billion with astonishing rapidity. Germany in 1929 had no such savior. Moreover, in 1994, Mexico could devalue the peso. In 1929, having only just emerged from a terrible bout of hyperinflation, Germany felt bound by gold-standard rules and sacrificed its economy to maintain the parity of the Reichsmark.

The second crisis of the series, the Great Crash, has a very obvious modern-day parallel in the fall of the stock market in 2000. Both followed a frenzied bubble in which stocks completely lost touch with economic reality, becoming grossly overvalued-by most measures 30 to 40 percent. In both cases, after the sell-off it became apparent that much of the rise had been pushed by a rogue's gallery of Wall Streeters and corporate insiders. Both resulted in similar losses initial in wealth expressed as a percentageof GDP-roughly 40 percent in the first year-and were followed by a sharp contraction in investment. The reaction of the authorities was not that dissimilar-in the first year after the 1929 crash interest rates in the United States were cut from 6 percent to 2 percent; in 2000 they were slashed from 6.5 percent to 2.0 percent.

The 1931-33 sequence of banking panics that started with the failure of the Bank of United States has many of the same characteristics as the current global financial crisis that began in the summer of 2007 and, as I write, is still sweeping through the world's banking system. Both originated with doubts about the safety of financial intermediaries that had sustained large losses. In 1931-33 those fears precipitated a series of bank runs, as depositors pulled their money out of banks and h.o.a.rded currency, that over a two-year period spread in waves across the United States. The present turmoil has also led to a ma.s.s run on the financial system-this time not by panicked individuals desperate to withdraw their money but by panicked bankers and investors pulling their money out of financial inst.i.tutions of all stripes, not only commercial banks but investment banks, money market funds, hedge funds, and all those mysterious "off-balance-sheet special-purpose vehicles" that have sprung up over the past decade. Every financial inst.i.tution that depends on wholesale funding from its peers has been threatened to a greater or lesser degree.

In some respects the current crisis is even more virulent than the banking panics of 1931-33. In the 1930s most depositors had to line up physically outside their bank to get their money. Now ma.s.sive amounts of money are being siphoned off with the click of a mouse. Moreover, the world's financial system has become both larger compared to GDP and more complex and interconnected. There is much greater leverage, and many more banks rely on short-term wholesale sources of funding that can evaporate overnight. The world's banks are therefore much more vulnerable than they were then. As a result panic has swept through the system faster and more destructively.