Lords of Finance_ The Bankers Who Broke the World Part 18

Offsetting this has been the response of central banks and financial officials. In 1931-33 the Fed stood pa.s.sively aside while thousands of banks failed, thus permitting bank credit to contract by 40 percent. In the current crisis, central banks and treasuries around the world, drawing to some degree on the lessons learned during the Great Depression, have reacted with an unprecedented series of moves to inject gigantic amounts of liquidity into the credit market and provide capital to banks. Without these measures, there is little doubt that the world's financial system would have collapsed as dramatically as it did in the 1930s. Though the net impact on credit availability of the present crisis and the remedial actions taken by central banks is still uncertain and won't be known for many months, the authorities seemed to have at least staved off a catastrophe.

Finally, the European financial crisis of 1931 also has its modern-day counterpart in the "emerging markets" crisis of 1997-98. In 1931, the evaporation of confidence in European banks and currencies caused Germany and much of the rest of Central Europe to impose capital controls and default on their debts, leading to a contagion of fear that culminated in forcing Britain off the gold standard.

In 1997, a similar sequence of rolling crises afflicted Asia. South Korea, Thailand, and Indonesia all had to suspend payments on hundreds of billions of dollars of debt. Asian currencies collapsed against the dollar, undermining all confidence in emerging-market securities and eventually setting off the default of Russia in 1998 and of Argentina two years later. But in 1931, that part of Europe affected by the crisis was about half the size of the U.S. economy; in 1997, the GDP of the emerging markets that defaulted represented about a quarter of U.S. GDP.

As with all a.n.a.logies, the comparisons are never exact. Nevertheless, they ill.u.s.trate the scale of the economic whirlwind of 1929-32-a crisis equivalent in scope to the combined effects and more of the 1994 Mexican peso crises, the 1997-98 Asian and Russian crises, the 2000 collapse in the stock market bubble, and the 2007/8 world financial crisis, all cascading upon one and other in a single concentrated two-year period. The world has been saved in part from anything approaching the Great Depression because the crises that have buffeted the world economy over the past decade have conveniently struck one by one, with decent intervals in between.

For many years people believed-even today many continue to do so-that an economic cataclysm of the magnitude of the Great Depression could only have been the result of mysterious and inexorable tectonic forces that governments were somehow powerless to resist. Contemporaries frequently described the Depression as an economic earthquake, blizzard, maelstrom, deluge. All these metaphors suggested a world confronting a natural disaster for which no single individual or group could be blamed. To the contrary, in this book I maintain that the Great Depression was not some act of G.o.d or the result of some deep-rooted contradictions of capitalism but the direct result of a series of misjudgments by economic policy makers, some made back in the 1920s, others after the first crises set in-by any measure the most dramatic sequence of collective blunders ever made by financial officials.

Who then was to blame? The first culprits were the politicians who presided over the Paris Peace Conference. They burdened a world economy still trying to recover from the effects of war with a gigantic overhang of international debts. Germany began the 1920s owing some $12 billion in reparations to France and Britain; France owed the United States and Britain $7 billion in war debts, while Britain in turn owed $4 billion to the United States. This would be the equivalent today of Germany owing $2.4 trillion, France owing $1.4 trillion, and Britain owing $800 billion. Dealing with these ma.s.sive claims consumed the energies of financial statesmen for much of the decade and poisoned international relations. More important, the debts left ma.s.sive fault lines in the world financial system, which cracked at the first pressure.

The second group to blame were the leading central bankers of the era, in particular the four princ.i.p.al characters of this book, Montagu Norman, Benjamin Strong, Hjalmar Schacht, and emile 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 sh.o.r.e 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 circ.u.mstances 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 a.s.sume 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. 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 a.s.sumed 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 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, 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.

TRANSLATING SUMS OF MONEY.

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.

ACKNOWLEDGMENTS.

I have been thinking about this book now for over a decade. In 1999, Time Time magazine featured a cover story ent.i.tled "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 magazine featured a cover story ent.i.tled "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 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 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. 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 d.i.c.kinson. 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 doc.u.ments and old newspapers clippings from archives in France and Germany; Felix Koch, who a.s.sisted 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 Reuze at the Banque de France for their help in tracking down letters, doc.u.ments, 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, and Shahid Yusuf.

I would like to express my grat.i.tude 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 G.o.doff 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.

Finally, I would like to thank my family. My constant companion while writing has been our dog Scout, who took over the armchair in my study. My two daughters, Shabnam and Tara, have now flown the coop, but from afar have humored-and also encouraged-their father in his endeavor to transform himself from investment manager to writer. No one has been a greater champion of that change than my darling wife, Meena. For thirty years, she has been my anchor. It is to her that this book is dedicated.

NOTES.

xi "Read no history": Disraeli Disraeli, Contarini Fleming, 141 141.

INTRODUCTION.

1 "I feel I want a rest": "Norman Sails Unexpectedly for a Vacation in Canada," New York Times, New York Times, August 16, 1931. August 16, 1931.

2 "monarch of [an] invisible empire": Kathleen, Woodward. "Montagu Norman: Banker and Legend," New York Times, New York Times, April 17, 1932. April 17, 1932.

2 "the citadel of citadels" and "Montagu Norman was the man": Monnet, Memoirs Memoirs, 95.

2 "the most exclusive club": New York Herald Tribune, New York Herald Tribune, July 10, 1927. July 10, 1927.

4 "We are today": Keynes, J. M., "An Economic a.n.a.lysis of Unemployment?" June 22, 1931, in Collected Writings, Collected Writings, 13: 343. 13: 343.

5 "In 1931, men and women": Toynbee, Survey of International Affairs Survey of International Affairs, 1.

5 "Unless drastic measures are taken": "Ein' Feste Burg." Time, Time, July 27, 1931, and Howe, July 27, 1931, and Howe, World Diary, World Diary, 111. 111.

5 It was rumored: Taylor, English History, English History, 290. 290.

5 "the wisest man": Letter from Lamont to Norman, December 4, 1946, cited in Schuker, The End of French Predominance in Europe The End of French Predominance in Europe, 291.

5 "might have stepped out": Snowden, Philip, "The Governor of the Bank of England," The Banker, The Banker, February 1926. February 1926.

6 "Everyone I meet": Ha.s.sall, Edward Marsh Edward Marsh, 570.

9 "second rate people," "the Jew is always a Jew": Chernow, The House of Morgan, The House of Morgan, 215, 310. 215, 310.

11 The pound sterling: There were 480 grains to a troy ounce, a measure of weight some 10 percent greater than a conventional ounce.

13 The totality of gold: The total amount of gold mined until 1913 was calculated to be 750 million ounces, or 22,500 tons. See Triffin. The Evolution of the International Monetary System, The Evolution of the International Monetary System, Table 17, 79. Because a cubic foot of gold is estimated to weigh about half a ton, this would amount to 45,000 cubic feet, equivalent to a cube with sides of about 35 feet. Table 17, 79. Because a cubic foot of gold is estimated to weigh about half a ton, this would amount to 45,000 cubic feet, equivalent to a cube with sides of about 35 feet.

13 "You came to tell us": Bryan, The First Battle: A Story of the Campaign of 1896 The First Battle: A Story of the Campaign of 1896, 199-206.

1: PROLOGUE.

19 "What an extraordinary episode": Keynes, Collected Writings: The Economic Consequences, Collected Writings: The Economic Consequences, 2: 6. 2: 6.

20 "a magnificent stupid honesty": Wells, The Work, Wealth, and Happiness of Mankind The Work, Wealth, and Happiness of Mankind, 398.

21 Even Kaiser Wilhelm: "Successful War No Advantage to Victor Says Angell," New York Times, New York Times, June 15, 1913. June 15, 1913.

21 In February 1912: Committee of Imperial Defense, Testimony of Sir John H. Lus...o...b.., Chairman of Lloyds, Report and Proceedings of the Standing Sub-Committee for the Committee of Imperial Defense on Trading with the Enemy, Report and Proceedings of the Standing Sub-Committee for the Committee of Imperial Defense on Trading with the Enemy, 1912, paragraphs 120-143. 1912, paragraphs 120-143.

21 "new economic factors," "commercial disaster": Esher, Journals and Letters, Journals and Letters, 211-28 and 229-261, quoted in Tuchman, 211-28 and 229-261, quoted in Tuchman, Guns of August Guns of August, 10.

2: A STRANGE AND LONELY MAN.

23 "Anybody who goes": Samuel Goldwyn quote from Bartlett's Familiar Quotations, Bartlett's Familiar Quotations, 695 695 23 "feeling far from well": Letter to Caroline Brown from Boyle, Montagu Norman Montagu Norman, 98.

27 "I feel a different person": Clay, Lord Norman Lord Norman, 44.

28 He would end up embracing: Boyle, Montagu Norman Montagu Norman, 87.

29 "with tears in his eyes": McEwen, The Riddell Diaries, The Riddell Diaries, 85. 85.

30 "the coming conflict": Geiss, July 1914: The Outbreak of the First World War July 1914: The Outbreak of the First World War, Doc.u.ment 162.

30 "acute anxiety": Wilson and Hammerton, The Great War The Great War, 26.

30 "stood nervously fingering their notes": "London Exchange Closes Its Doors." New York Times, New York Times, August 1, 1914. August 1, 1914.

31 "although many hundreds of people," "traditionally phlegmatic and cool": Times, Times, August 1, 1914. August 1, 1914.

31 Nevertheless, just in case: "English Bank Act to Be Suspended." New York Times, New York Times, August 2, 1914. August 2, 1914.

31 "in case of an outbreak": Memorandum by Sir Felix Shuster, director of the Union Bank of London, circulated to the Clearing Bankers' Gold Reserves Committee quoted in Kynaston, The City of London: Golden Years, The City of London: Golden Years, 588. 588.

32 "European prospects very gloomy": Clay, Lord Norman Lord Norman, 81.

32 "Financiers in a fright": Lloyd George, War Memoirs, War Memoirs, 111. 111.

32 "shook his fist": Sayers, The Bank of England The Bank of England, 75.

33 "I have been at work": Boyle, Montagu Norman Montagu Norman, 98.

3: THE YOUNG WIZARD.

36 One of those who: Chernow, The Warburgs The Warburgs, 153.

36 The famously indiscreet kaiser: Ferguson, The Pity of War The Pity of War, 191.

36 There was also talk: Wilson and Hammerton, The Great War The Great War, 68.

37 "considerably outshone his fellow directors": Somary, The Raven of Zurich, The Raven of Zurich, 71. 71.

37 "curiously stiff gait": Bonn, Wandering Scholar Wandering Scholar, 303.

38 "a restless wanderer": Schacht, My First Seventy-six Years My First Seventy-six Years, 24.

38 "sentimental, gay and full of feeling": Goldensohn, The Nuremberg Interviews The Nuremberg Interviews, 231.

41 "Germany's steady advance": Schacht, My First Seventy-six Years My First Seventy-six Years, 129.

42 a large "howling mob": Tuchman, The Guns of August The Guns of August, 129.

42 Bizarre rumors spread: Wolff, The Eve of 1914 The Eve of 1914, 524.

43 "The next time": Charles A. Conant, "How Financial Europe Prepared for the Great War," New York Times, New York Times, August 30, 1914. August 30, 1914.

44 "a tremendous solemnity": Schacht, My First Seventy-six Years My First Seventy-six Years, 60.

4: A SAFE PAIR OF HANDS.

45 "Show me a hero": F. Scott Fitzgerald quote from The Yale Book of Quotations, The Yale Book of Quotations, 274. 274.

45 Strong had been elected president: "E. C. Converse Drawing Out," New York Times, New York Times, January 9, 1914. January 9, 1914.

45 He had left the United States: "Cloud and Rain Mar Berlin Season," New York Times, New York Times, June 14, 1914. June 14, 1914.

47 Finished from floor to ceiling: "No Morgan Bower atop Bankers Trust," New York Times, New York Times, May 16, 1912. May 16, 1912.

47 In 1912, during the Pujo Committee hearings: "Five Men Control $368,000,000 Here," New York Times, New York Times, December 11, 1912. December 11, 1912.