Lords of Finance_ The Bankers Who Broke the World Part 3

In 1805, immediately following the naval disaster at Trafalgar and just as Napoleon was launching his latest campaign against the Austro-Russian alliance, a panic among the merchants of Paris precipitated a run on the still infant Banque and almost forced it into liquidation. It was saved when news arrived in the capital of Napoleon's brilliant victory at Austerlitz. While confidence was quickly reestablished in the new Banque, lubricated by large indemnity from the Austrians, Napoleon remained enraged by the feeble-heartedness of his bankers.

On his return from Austria, he summoned his council of ministers and, in one of his imperial tantrums, fired his minister of finance. To the Banque's three-man management committee he offered the choice between prison or a fine of 87 million francs. They chose the fine. Determined never again to be held hostage by moneymen, Napoleon changed the Banque's statutes so that henceforth the governor and the two deputy governors would be appointed directly by the government, which at that time meant Napoleon himself. He declared at the time, "The Banque does not belong only to its shareholders, but also to the state. . . . I want the Banque to be sufficiently in government hands without being too much so."

For emile MOREAU the war meant a continuation of his exile at the head of the Banque d'Algerie. In 1914, after Henriette Caillaux's acquittal, he must have secretly harbored some hope of returning to the Ministry of Finance on his mentor Caillaux's coattails. But this was quickly squashed with the outbreak of war, for Caillaux, always viewed as soft on Germany, was not invited into the war government.

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

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

OBEDIENCE AND SUBORDINATION.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

A SCOUTING TRIP.

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

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

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

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

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

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

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

While the cause of the disease had been isolated in the late nineteenth century, there was still no effective therapy. Half of those who contracted it were dead within five years. At the time, it was thought that the thin dry air in high alt.i.tudes helped to contain the infection-with some grounds because its virulence declines in low-oxygen atmospheres. It was also believed-erroneously, it turned out-that total inactivity and complete rest allowed the lungs to rebuild themselves. Luxury sanatoria catering to the rich and the middle cla.s.s, cut off from the rest of the world, had sprung up in mountain resorts across Europe and America.

Strong's doctors insisted that he take an extended leave of absence from the Fed. In July 1916, he moved to Colorado, where almost a third of the population was then made up of "consumptives" seeking to be cured. He initially checked into a sanatorium in Estes Park, in the heart of the northern Colorado Rockies, but frustrated by this hermetically sealed world where patients spent hours doing nothing but sitting outdoors taking in the mountain air, he moved to Denver that October and set up a small office that allowed him to keep in touch with New York.

Strong was still convalescing in Colorado when the United States entered the war in April 1917. Within six weeks, he was back in New York. For the next eighteen months he threw himself into the task of raising the money to pay for the war. Every other objective of the Fed was now subordinated to this goal. The United States spent in total some $30 billion on the war, a little over $20 billion on its own actual expenditures and another $10 billion in the form of loans to keep other countries going.12 Determined to avoid the mistakes that had been made in financing the Civil War, the secretary of the treasury, William McAdoo, who also happened to be the president's son-in-law, launched an aggressive program to induce the American public to purchase war debt. The Fed, as banker to the government, was responsible for selling these so-called Liberty Bonds, which eventually brought in close to $20 billion, about half of this raised by the New York Fed. Determined to avoid the mistakes that had been made in financing the Civil War, the secretary of the treasury, William McAdoo, who also happened to be the president's son-in-law, launched an aggressive program to induce the American public to purchase war debt. The Fed, as banker to the government, was responsible for selling these so-called Liberty Bonds, which eventually brought in close to $20 billion, about half of this raised by the New York Fed.

Taking the lead in organizing the high-pressure campaigns in New York to stir public enthusiasm for the bonds, Strong suddenly found himself thrust into the limelight. Acting as the master of ceremonies for concerts at Carnegie Hall or at the Metropolitan Opera House, leading great patriotic marches down Fifth Avenue, speaking at rallies featuring such Hollywood celebrities as Mary Pickford and Douglas Fairbanks, he became something of a minor celebrity himself. Publicity stunts were a signature of these campaigns. On one occasion Strong and the other organizers had trenches dug in the Sheep Meadow in Central Park-much to the outrage of conservationists-to show how soldiers were living on the Western Front. To kick off another campaign, they arranged for every air-raid siren, police alarm, tugboat whistle, fire engine bell, and ship fog-horn across the city to be turned on for five minutes.

By the time the war drew to a close, the Fed was a transformed inst.i.tution. While it was not completely immune from the pressures of war finance, unlike so many European central banks, it had resisted purchasing government bonds directly and only indirectly helped to fuel the expansion in money supply. It had therefore secured some credibility. More important, the war had irrevocably changed the economic and financial position of the United States in relation to the rest of the world. The Fed, which barely existed in 1914, now sat on the largest reservoir of gold bullion in the world, making it potentially the dominant player if and when the international gold standard was restored.

PART TWO.

AFTER THE DELUGE.

1919 -23.

7. DEMENTED INSPIRATIONS.

German REPARATIONS Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.

-JOHN MAYNARD KEYNES, The Economic Consequences of the Peace

ON November 11, 1918, the Great War came to an end as it had begun, as a total surprise. In June 1918, the German army broke through the Allied lines, and came within fifty miles of Paris. The German public, given a distorted picture by its government, fully antic.i.p.ated victory. A month later, the Allies counterattacked and suddenly the entire German war machine seemed to disintegrate. The German forces, exhausted by that last offensive, withered away; support for the war at home crumbled; civilian morale collapsed; soldiers deserted in droves; the navy, blockaded at Kiel, mutinied; and Germany's allies began to sue secretly for peace. By October, the military, desperate to salvage what it could, turned over power to the civilians. On November 9, the kaiser was forced into exile by his generals, boarding a train for Holland. Early on November 11, in a railway carriage in the forest of Compiegne forty miles outside Paris, an armistice was signed.

Across Europe some 11 million men lay dead, including 2 million Germans, 1.4 million Frenchmen, and 900,000 British. Another 21 million had been wounded, very many maimed for life. Nine million civilians had perished, mostly of hunger, cold, or lowered resistance to the monstrous epidemics. But for all the horrendous human carnage, the actual material destruction of the war was limited to a long but narrow strip of northern France and Belgium. The costs of rebuilding the mines, farms, and factories destroyed on the Western Front amounted to only $7 billion.

Most European economies had contracted-Germany's and France's by 30 percent, Britain by less than 5 percent-as men and capital were siphoned off, as factories diverted to producing arms, and livestock slaughtered. The war had been a boon for the United States. Entering late, it had suffered fewer casualties, while the ma.s.sive expansion in exports of foodstuffs, raw materials, and war supplies to its allies had provided a gigantic boost to its economy. Before the war, its GDP of $40 billion per annum was roughly the equivalent of that of Britain, France, and Germany combined. By 1919, it was more than 50 percent larger.

The most pernicious and insidious economic legacy of the war was the mountain of debt in Europe. In four years of constant and obsessive battle, the governments of Europe had spent some $200 billion, consuming almost half of their nations' GDP in mutual destruction. To pay for this, they had raised taxes, borrowed gigantic amounts of money both from their own citizens and from the Americans, and simply printed more and more currency. By the end of the war, Europe was awash with the stuff-the money supply in Britain doubled, in France it tripled, and in Germany, the worst culprit, it quadrupled. Though the U.S. money supply also doubled, this was less because of inflationary war finance, which it relied upon to a much smaller extent than the Europeans, and more because of the ma.s.sive influx of gold. This set the pattern of the next decade: Europe struggling with the legacies and burdens of the past, the United States wrestling with the excess bonuses of its good fortune.

ON THE DAY the kaiser fled Germany, Schacht was in Berlin. That morning, although the kaiser had not actually abdicated-and would only formally do so two weeks later from his sanctuary in Holland-the chancellor, Prince Max of Baden, a distant cousin of the kaiser's, announced preemptively that the emperor had gone. The city was like an armed camp, with barbed-wire entanglements and overturned vehicles blocking the streets. Revolution was in the air. A general strike had been declared, and thousands of workers and soldiers paraded through the center of town demanding a republic.

Coming out of the Hotel Esplanade near the Potsdammerplatz at about noon, Schacht was confronted by a convoy of Red soldiers packed in the back of trucks driving across the square. At the station, a machine-gun company was positioned for action. No one seemed to be in charge. To find out what was going on, and to avoid being caught in the mob, Schacht and his companion headed north toward the Reichstag, which they found deserted. A little while before, Philipp Scheidemann, a leader of the Social Democrats, had given history a push by coming out onto the balcony and proclaiming a republic to the crowds below, although no such measure had been pa.s.sed by the Reichstag. Thus was born the new Republic of Germany. The mobs had then headed off to the emperor's abandoned palace, the Berliner Schloss.

Schacht would remark later that there was a certain distinctively German order amid all the chaos of that dramatic day. The imperial dynasty might have fallen and the political system of Germany overturned, but ordinary people went about their everyday business, trying to ignore the demonstrations. The trams did not stop running; electricity, water, and gas supplies were not interrupted; and almost no one was killed-the casualties that day amounted to fewer than fifteen dead. Even when shots were randomly fired near the palace, the fleeing crowds remained so instinctively law abiding that they obeyed the signs to keep off the gra.s.s.

Across the country, workers' and soldiers' councils sprang up and took over the functions of the local authorities. On November 10, Schacht was elected, much to his amus.e.m.e.nt, to his local community council. After issuing a proclamation welcoming the revolution, it met precisely once more.

The next few weeks were a time of terrible turmoil. Although the November revolution was largely peaceful, by the first weeks of January, violence had broken out and Berlin was wracked by strikes, demonstrations, and fierce street fighting between the Spartacist revolutionaries and the army. It seemed to Schacht then, as to very many others, that Germany was the front line in a grand battle across Europe against the forces of Bolshevism. Going home through the darkened city, he could hear the rattle of machine guns. On one occasion, he was stuck in the Hotel Kaiserhof as a gang of Spartacist demonstrators clashed with a group of government supporters outside. A hand grenade burst among the crowd, scattering it in all directions and leaving one man dead in the street below. The "fate of Germany hung by a thread," he recalled many years later.

It was also, however, a time of opportunity for middle-cla.s.s men of talent like Schacht. The collapse of empire and an army in defeat shattered the old order. Within forty-eight hours of the kaiser's flight, twenty-five dynasties had abdicated within Germany. The Junkers who had dominated the country were discredited, their power swept away.

Initially Schacht thought he might find his opportunity in politics. Before the war, he had been a member of the Young Liberal a.s.sociation, an arm of the National Liberals, a nationalistic though not very liberal party, which had enthusiastically supported the kaiser's expansionist policies. In 1901, he had even declined an offer from the party to stand for election to the Reichstag, knowing that power in the Kaiserreich was reserved for the n.o.bility, especially the Prussian n.o.bility, and that a man of his background could not aspire to political office of any consequence. But with the new president of the republic himself a former saddler and the new chancellor a former journalist, it seemed that the old caste system had now disintegrated.

On November 10, the republic only a day old, Schacht was invited to a meeting and asked to help found a new moderate party, the Deutsche Demokratische Partei (DDP), which would oppose alike the socialism of the left and the nationalism of the right. The DDP itself would briefly do very well, becoming a party of academics, journalists, and businessmen, many of them Jewish, and attracting such luminaries as Max Weber and Albert Einstein. In the 1919 election, it vaulted into third place in the Reichstag, after the Socialists and the Catholic Centrum Party.

But Schacht's brief flirtation with democratic politics was not destined to be very successful. With his financial and business connections, he played an important role in raising funds for the DDP, and helped write the party platform. But lacking the common touch that appealed to voters and too proud to forge the necessary personal alliances, he was never able to persuade a const.i.tuency to select him as a candidate. He was also viewed with some suspicion within the leadership, whose leading light, Theodor Woolf, editor of the Berliner Tageblatt, Berliner Tageblatt, regarded him as just one more opportunist trying to hitch a ride on the cause of democracy, with little commitment to the new republic. regarded him as just one more opportunist trying to hitch a ride on the cause of democracy, with little commitment to the new republic.

For his part, Schacht would become steadily disillusioned with the party, formally breaking with it in 1925, when it voted to support the elimination of privy purses to the deposed ruling families. In the late 1920s, the DDP, like all German centrist parties, would shrink into insignificance, squeezed from both ends of the political spectrum, particularly from the right. By then, though, Schacht had moved on to bigger things.

It was perhaps not surprising that he had such little success in electoral politics. He was simply a hard man to like. People found him cold and unemotional, overly calculating and shrewd. By his own admission, he came across as "hard . . . callous . . . and b.u.t.toned down." It was partly his appearance. One acquaintance remarked, "He managed to look like a compound of a Prussian reserve officer and a budding Prussian judge who is trying to copy the officer." His physically distinctive characteristics-the crew cut, the rigid bearing, the stiffly upright posture, the perpetual aggressive scowl-would, after he had become famous, make him a popular target for cartoonists.13 But more than his appearance, it was his character traits-his extreme vanity, his tendency to talk about himself and his achievements, his inflexibility, his caustic wit laced with cynicism-that put people off. But more than his appearance, it was his character traits-his extreme vanity, his tendency to talk about himself and his achievements, his inflexibility, his caustic wit laced with cynicism-that put people off.

He displayed an astounding self-confidence. This was not a facade, but a reflection of his astonishing sense of innate superiority. He was in many ways a cla.s.sic lower-middle-cla.s.s overachiever. Having grown up poor, in a society where cla.s.s and family background were still overwhelming factors, he had learned the hard way that in a hostile world he could rely only on himself. Whatever success he had achieved, he owed to himself alone-his own formidable intelligence and impressive capacity for hard work. "Nothing seems sacred to him except his belief in himself, and this is so overwhelming as no longer to seem personal. He makes the most exaggeratedly egotistical statements without his hearer being aware of any personal boasting," wrote one observer. And unlike some men on the make, who cloak their cynicism behind a veneer of charm, he displayed no particular desire to be liked. Much later, when his true colors had been revealed, one politician would write, "He was a man apart, unique, solitary, without followers or any coterie of partisans. He had no friends, only enemies." But no one could dispute his self-discipline, energy, and unrelenting drive.

THE problem of German reparations-that is, how much of the cost of the war the victors, particularly Britain and France, could demand from Germany-was to haunt the financial landscape of Europe for the next twenty years. The war may have ended, but the conflicts did not stop. At the Paris Peace Conference, which opened in January 1919, no other issue "caused more trouble, contention, hard feeling, and delay," recalled Thomas Lamont, one of the American negotiators.

Everyone arrived in Paris expecting France, which had suffered the worst civilian damage and heaviest casualties, to be the strongest advocate of punitive reparations against Germany. Instead, it turned out to be Britain. A strong liberal contingent within the British Treasury had developed peace plans based on a moderate settlement. But in the months leading up to the Peace Conference, the press, led by the Times Times and the and the Daily Mail Daily Mail, launched a cheap jingoistic campaign in favor of a harsh settlement and, during the December 1918 election campaign, the slogan that the Allies should "squeeze Germany until the pips squeak"14 struck a chord with the electorate. struck a chord with the electorate.

The British prime minister, David Lloyd George, pandering to public opinion, appointed to the British delegation to the Reparations Commission in Paris three of the most hard-line advocates of a punitive settlement: William Hughes, the doggedly aggressive prime minister of Australia; Lord Sumner, a law lord with a reputation for being "stony-hearted"; and Lord Cunliffe, the boorish and irascible former governor of the Bank of England.

Cunliffe was supposed to be the financial brains of this trio. Although he had been a successful banker and even governor of the Bank of England, he retained his ignorance of the most basic rudiments of economics. In the weeks before departing for Paris, he recommended that Germany be required to pay $100 billion in reparations. It was an astounding figure. Germany's annual GDP before the war had been around $12 billion. To burden it with a debt eight times its annual income would have been the height of madness. The interest on that debt alone would have consumed 40 percent of its GDP. Though Cunliffe was willing to admit that the basis for the calculation was "little more than a shot in the dark," which he had been pressed to arrive at "between a Sat.u.r.day and a Monday," he speculated that perhaps he had even underestimated Germany's capacity to pay, and that if anyone argued that Germany could pay $200 billion, he "would not disbelieve him."

France's desire for reparations arose from its own sense of vulnerability. Twice invaded by Germany in the last fifty years, France was consumed by the fear of a German revival. Germany was more aggressive, more successful, younger, richer, and more dynamic. It was also 50 percent larger-sixty million Germans versus forty million Frenchmen. Though the French prime minister, George Clemenceau, never actually made the statement attributed to him by German propaganda, that the fundamental problem was that there were twenty million too many Germans, it was clearly in his mind. France was therefore determined to weaken Germany by every means possible-by disarmament, by slicing off as many parts of its neighbor as it could, and by extracting reparations.

During the negotiations in Paris, it became apparent that to the French, money was subsidiary to security. While the French finance minister, Lucien Klotz, kept pushing for high reparations, Clemenceau, the head of the French delegation, treated him with contempt, calling him "the only Jew who knows nothing about money" and marginalizing him along with all the other French cabinet members in the negotiations.15 Clemenceau tried to be flexible on reparations as a bargaining chip with the Americans in return for security guarantees along their border with Germany. Only when the guarantees proved to be inadequate did he revert to demanding high reparations. Clemenceau tried to be flexible on reparations as a bargaining chip with the Americans in return for security guarantees along their border with Germany. Only when the guarantees proved to be inadequate did he revert to demanding high reparations.

It fell to the American delegation, which included the famous stock market speculator Bernard Baruch; Thomas Lamont of J. P. Morgan and Co.; and a young aide, the thirty-one-year-old John Foster Dulles, to act as the advocates for moderation. They adopted the position that a large reparations bill was incompatible with the initial terms of the armistice agreement under which Germany had laid down its arms. Moreover, they argued that punitive reparations would act as a millstone, not simply around Germany's neck but around that of all Europe.

The negotiations over reparations dragged on for ten weeks. By the end of March, they were still at an impa.s.se. The British delegation on the Reparations Commission, led by Lord Cunliffe and Lord Sumner, who were by then nicknamed "The Heavenly Twins" because they were always together and insisted on such outrageously high figures, would not agree to a settlement of less than $55 billion.

The Americans preferred a settlement in the region of $10 to $12 billion and would go no higher than $24 billion. Although President Wilson was, for the most part, outnegotiated and outfoxed by the other leaders in Paris, on this point the American delegation stuck to their guns and refused to agree to reparations that exceeded these limits.

Several attempts were made to break the deadlock. Lloyd George himself applied his considerable political skills, but Cunliffe and Sumner refused to budge. Lloyd George's maxim was never to enter into "costly frontal attacks, either in war or politics, if there was a way round" and he had originally appointed them in the hopes of bamboozling them into endorsing a moderate settlement. Now he found himself captive to their intransigence. His solution was to do an end run around them by proposing, at the last minute, that the Peace Conference defer the a.s.sessing of reparations to a later date, delegating it to a specially appointed body, which would be required to make its recommendation no later than May 31, 1921. He hoped that by that time, pa.s.sions would have cooled, the political climate in Britain would have changed, and a more reasonable settlement could be arranged.

IN THE FIRST few months of 1919, as the Peace Conference was getting under way, Schacht, lulled like many other Germans by the high-minded p.r.o.nouncements of Woodrow Wilson, still expected a generous peace. He believed that the real problem would be the overhang of debt after the war, which would lead to a general European bankruptcy. He talked naively of a grand plan for reconstruction. The great natural resources of Russia would be opened up for exploitation by a unique partnership between Great Britain and Germany, Britain providing the leadership and capital, Germany the manpower and engineering skills.

In May 1919, when the terms of the peace treaty were finally unveiled to Germany, the whole country exploded in shock and anger. It was to lose one-eighth of its territory. Alsace and Lorraine were to revert to France; the Saar coal mines were also ceded to France; North Schleswig was to be subject to a plebiscite as to whether it wished to become part of Denmark; Upper Silesia, Posen, and West Prussia went to Poland. Both banks of the Rhine were to be permanently demilitarized; the army was to be cut to no more than one hundred thousand men, the navy was to be dismantled, and the merchant marine distributed to the Allies. Though the Allies had delayed fixing the size of reparations, it was widely known that the amounts being mooted were gigantic. In the interim, Germany was required to pay an initial $5 billion before May 1, 1921. A new Reparations Commission, to be based in Paris, was created specifically to determine Germany's liability and to supervise its collection. The worst humiliation was Article 231, the "article of shame," which branded Germany as solely responsible for the war.

The reaction within Germany to the peace treaty reached a pitch of hysteria. All forms of public entertainment were suspended for a week as a sign of protest. Flags across the country were lowered to half-mast. The chancellor, Philipp Scheidemann, characterized the terms as "unbearable, unrealizable, and unacceptable," and proclaimed that it would make the Germans "slaves and helots . . . doing forced labor behind barbed wire and prison bars." The Germans were given a deadline of five days to agree to the terms or face a resumption of hostilities. Scheidemann resigned rather than put his signature on the doc.u.ment, of which he said, "What hand would not wither which placed this chain upon itself and upon us?" On the day that Germany accepted the terms, its Protestant churches declared a day of national mourning.

Behind all the divisions that were to wrack Germany for the next few years, the one single factor that united every cla.s.s and every political party-democrats and royalists, liberals and Socialists, Catholics and Protestants, northerners and southerners, Prussians, Bavarians, Saxons, and Hessians-was the injustice of the peace treaty, or as it was called the Diktat. And of all the various penalties heaped on Germany by the treaty-disarmament, dismemberment, occupation, and reparations-it was reparations that would become the single most consuming obsession of German foreign policy. Germany had meekly agreed to reduce its military machine to a shadow of its former power, thus leaving it impotent to do anything about the loss of territory or of its colonies. Only on reparations did Germany seem able to fight back. It discovered what every large debtor at some point discovers: that when one owes a large amount of money, threatening to default can give one the upper hand.

Schacht's first introduction to the issue of reparations came in the fall of 1919. He was asked to join a group of industrialists and businessmen sent to The Hague to negotiate with the Allied commission on the delivery of goods in kind as part of the interim settlement. The German delegation was subjected to a litany of petty humiliations: they were forced to stay at the worst hotel, given bad food, their movements restricted, and they were openly followed. Finally, during the negotiations themselves, they were not even provided with chairs but were required to stand. When Schacht complained, he was told, "You seem to forget that your country lost the war." It was Schacht's first encounter with what he was to call the "medieval arrogance" of the victors.

IRONICALLY, IT WAS not a German but an Englishman who launched the most devastating attack on reparations. In November 1919, John Maynard Keynes, the young Cambridge don, published The Economic Consequences of the Peace. The Economic Consequences of the Peace. In the book Keynes argued that in order for Germany to earn the money to pay the Allies, it would have to sell more goods than it bought, and its trade partners would have to be willing to absorb this large influx of goods, with potentially crippling consequences for their own industries. It was therefore in the Allies' own self-interest to moderate their demands. As he put it, "If Germany is to be milked, she must not first of all be ruined." He concluded that the most Germany could afford to pay, without causing a ma.s.sive disruption of world trade, was around $6 billion. In the book Keynes argued that in order for Germany to earn the money to pay the Allies, it would have to sell more goods than it bought, and its trade partners would have to be willing to absorb this large influx of goods, with potentially crippling consequences for their own industries. It was therefore in the Allies' own self-interest to moderate their demands. As he put it, "If Germany is to be milked, she must not first of all be ruined." He concluded that the most Germany could afford to pay, without causing a ma.s.sive disruption of world trade, was around $6 billion.

The book became an immediate best seller; over one hundred thousand copies were bought worldwide in its first six months alone. It was serialized in the United States in the New Republic New Republic and in France by and in France by La Nouvelle Revue Francaise La Nouvelle Revue Francaise and translated into French, German, Dutch, Flemish, Danish, Swedish, Italian, Spanish, Romanian, Russian, j.a.panese, and Chinese. At the age of thirty-six, Keynes's brilliant pen had carried him to fame, not merely in Britain but across the world. and translated into French, German, Dutch, Flemish, Danish, Swedish, Italian, Spanish, Romanian, Russian, j.a.panese, and Chinese. At the age of thirty-six, Keynes's brilliant pen had carried him to fame, not merely in Britain but across the world.

From an early age, people had remarked on young Maynard's intellect, which had been carefully nurtured from his childhood. Born in 1883, in Cambridge, England, he spent most of his life in and around Cambridge University. His father, John Neville Keynes, was a don, a philosopher, and logician of great early promise but little ambition who had drifted into university administration. Maynard spent four years at Eton, where he was one of those golden boys known both for their extraordinary academic achievement and their social popularity, and in 1902 he entered King's College, Cambridge, to read mathematics. He was soon elected to that elite intellectual society nicknamed "the Apostles," which already included G. E. Moore, Bertrand Russell, and Lytton Strachey. He spent his years at Cambridge absorbed in a hothouse combination of high-minded philosophical debate and h.o.m.oerotic entanglements with his fellow Apostles. Even Bertrand Russell, rarely impressed by other people's brainpower, wrote that Keynes' intellect was "the sharpest and clearest that I have ever known."

After graduating in 1904, Keynes briefly tried to escape the university by joining the India Office as a "clerk"-he had only come second in the civil service exams and missed being selected for the Treasury, though he would characteristically insist that it was because "I evidently knew more about economics than my examiners." Within a year of going to the India Office, he resigned. Even though the hours were not at all taxing-he worked from 11:00 a.m to 5:00 p.m. on weekdays, 11:00 a.m. to 1:00 p.m. on Sat.u.r.days, and had eight weeks' vacation a year plus Derby Day-he had found that he did not have enough to do. His a.s.signments included organizing the shipment of ten Ayrshire bulls to Bombay and preparing an annual report to Parliament, "The Moral and Material Progress of India." Amused by the Victorian pomposity of the whole exercise, he joked to Lytton Strachey that he planned to include "an ill.u.s.trated appendix on Sodomy." Bored with the work and finding it difficult to restrain his natural irreverence toward authority, he returned to Cambridge.

While he almost immediately gained a lectureship in economics at the university, his first love had always been philosophy. In 1909, he began work on a book on the philosophical foundations of probability, which he hoped would change the way philosophers thought about uncertainty. The themes of the book-that nothing can be known with certainty, that it is hard to define what is a rational course of action when the future is so indeterminate, that intuition rather than a.n.a.lysis provides the ultimate basis for action in these circ.u.mstances-were to color much of his later economic thinking and his almost equally remarkable ability to make money from speculating.

But for all his pa.s.sion for abstract ideas and philosophical discussions, Keynes also had wider and worldlier ambitions. In addition to his teaching duties and the book on probability, he spent the years before the war as a member of the Royal Commission on Indian Currency and Finance, even publishing a book on the subject; he took over the investment portfolio of his college; wrote occasional pieces on financial matters for the Morning Post Morning Post and the and the Economist Economist; and became the editor of the Economic Journal, Economic Journal, to which he also contributed articles and reviews. Then there were his hobbies-the magnificent collections of old books and modern paintings, his golf, his pa.s.sion for the ballet-and his many remarkable and varied friends. Indeed, there were times when he almost seemed to have too many interests. to which he also contributed articles and reviews. Then there were his hobbies-the magnificent collections of old books and modern paintings, his golf, his pa.s.sion for the ballet-and his many remarkable and varied friends. Indeed, there were times when he almost seemed to have too many interests.

To accommodate all these activities, he would spend a couple of days every week in London, where he shared a house at 38 Brunswick Square with some of his Bloomsbury friends-among them Adrian Stephen and Adrian's sister Virginia and her husband Leonard Woolf-many of whom he had met as an undergraduate at Cambridge. But while his bohemian comrades viewed the world of money and power as somehow tainted, he very much wanted to be part of it.

His chance to return to government came with the war. On Sunday, August 2, he was in Cambridge when he received a letter from an old colleague at the UK Treasury, Basil Blackett. "I tried to get hold of you yesterday but found that you were not in town. I wanted to pick your brains for your country's benefit and thought you might enjoy the process. If by chance you could spare time to see me on Monday, I should be grateful, but I fear the decisions will all have been taken by then." Such an invitation from a man he respected, offering access to the center of world affairs, was irresistible. Unwilling to wait for the next train up to London, he persuaded his brother-in-law, A. V. Hill,16 to take him up to London in the sidecar of his motorcycle. By the end of the day, Keynes was ensconced in the Treasury Building in Whitehall, busy drafting a note for the chancellor on whether Britain should follow the rest of Europe into abandoning the gold standard. Within a few months, he had a job as a junior economic adviser within the Treasury. to take him up to London in the sidecar of his motorcycle. By the end of the day, Keynes was ensconced in the Treasury Building in Whitehall, busy drafting a note for the chancellor on whether Britain should follow the rest of Europe into abandoning the gold standard. Within a few months, he had a job as a junior economic adviser within the Treasury.

He quickly rose within its rank. In early 1917, he became chief of the external finance division responsible for securing enough dollars on reasonable terms to pay for the war effort and keep the UK economy afloat. It was perhaps the most critical economic issue confronting Britain during the war, and put Keynes at the heart of economic policy making.

He became completely absorbed in the heady atmosphere of life as an establishment mandarin, thrown into the highest social and political circles. He was invited for country weekends by the prime minister and his wife, played bridge at No. 10 Downing Street, spent the weekend at the home of the chancellor of the exchequer, dined with the Duke of Connaught and the Princess of Monaco. He was, in the words of the society hostess Ottoline Morrell, "greedy for work, fame, influence, domination, admiration."

That combination of success and cleverness could at times make him insufferable. His Bloomsbury friends, who inhabited a rarified world of art and literature and ideas, were able to tease him about his newfound connections in high places. They were even willing to tolerate his irritating c.o.c.ksureness. He was redeemed in their eyes by the subversive pleasure he took in challenging authority. No one was immune from his witty and biting ripostes. Within just a few months of joining the Treasury, he told no less than Lloyd George, the chancellor of the exchequer, during a meeting, "With the utmost respect, I must, if asked my opinion, tell you that I regard your account as rubbish." But to the many other people to whom he was rude or insulting, he was simply an arrogant young man with an overblown sense of his own intellectual superiority.