Lords of Finance_ The Bankers Who Broke the World Part 4

One would not have guessed at all of this by looking at him. He looked so very ordinary-receding chin, thinning hair, feeble military mustache-and he dressed so conventionally-dark three-piece suits and a homburg, or sometimes a bowler. At first glance he might have been a modestly successful City drone-an insurance broker maybe-or possibly a minor civil servant.

Beneath that superior facade he actually harbored some profound insecurities-especially about his looks. "I have always suffered and I suppose always will from a most unalterable obsession that I am so physically repulsive that I've no business to hurl my body on anyone else's," he once confessed to his friend Lytton Strachey. But most of those who were close to him agreed that he could be the most attractive and charming of companions, his conversation sparkling, brilliant, and witty. He was "gay and whimsical and civilized" with "that gift of amusing and surprising, with which very clever people, and only very clever people, can by conversation give a peculiar relish to life," remembered the art critic Clive Bell.

Most of Keynes's Bloomsbury crowd were conscientious objectors. As the war dragged on, he himself became increasingly disillusioned with its terrible waste, the relentless loss of lives, the refusal of the politicians to contemplate a negotiated settlement, and the steady erosion of Britain's financial standing. In 1917, he wrote to his mother that the continuation of the war "probably means the disappearance of the social order we have known hitherto. With some regrets I think I am not on the whole sorry. The abolition of the rich will be rather a comfort and serve them right anyhow. What frightens me is the prospect of general impoverishment. . . . I reflect with a good deal of satisfaction that because our rulers are as incompetent as they are mad and wicked, one particular era of a particular kind of civilization is very nearly over."

When the war ended, Keynes was appointed the princ.i.p.al Treasury representative at the Paris Peace Conference. Though his official t.i.tles included deputy to the chancellor of the exchequer on the Supreme Economic Council, chairman of the Inter-Allied Financial Delegates in the Armistice negotiations, and representative of the British Empire on the Financial Committee, he soon found himself completely excluded from the most important economic negotiations at Paris, those on reparations. He had to watch impotently from the sidelines as the "nightmare" of the Peace Conference was played out. As he later wrote, "a sense of impending catastrophe overhung the frivolous scene." When the terms of the treaty were finally announced in the middle of May, exhausted and disgusted, he felt he had no alternative but to resign. He wrote to Lloyd George, "The battle is lost. I leave the Twins [Sumner and Cunliffe] to gloat over the devastation of Europe."

THE ECONOMIC CONSEQUENCES of THE PEACE was a strange book to have sold so well. Two-thirds of it comprised a detailed, often technical, polemic against reparations. At the time and even after, the whole debate over reparations was obfuscated by the enormous figures involved. They were simply too large and abstract for most people, including politicians and many bankers, to comprehend, particularly in an era when few people knew what the GDP of Germany or Britain was or even what the term meant. Keynes was able to pierce through all of this confusion and translate the tens of billions of dollars that were being bandied about so readily into something more tangible for the average man to grasp.

A book replete with figures and tables on the value of the housing stock of France and Belgium, the composition of German exports and imports in 1914, and estimates of the size of the German railway rolling stock may have been unlikely material for a best seller. But the sheer physicality of the technical details served as a chilling reminder that behind all of the abstract figures, this was an argument about the concrete things necessary to sustain standards of living.

Its success was partly due to the artfully mordant portraits he drew of the Big Three at Paris: Clemenceau, "dry in soul and empty of hope, very old and tired"; Wilson, "his thought and his temperament . . . essentially theological not intellectual"; "his mind . . . slow and unadaptable"; and Lloyd George, "with six or seven senses not available to ordinary men, judging character, motive and subconscious impulse, perceiving what each was thinking and even what each was going to say next." Keynes was persuaded by several people, including his mother, to omit some of the best but most inflammatory descriptions-especially the portrait of Lloyd George, "rooted in nothing; he is void and without content . . . one catches in his company the flavor of final purposelessness, inner irresponsibility, existence outside or away from our Saxon good and evil, mixed with cunning, remorselessness, love of power."

What seemed to have captured the public imagination was the outline of the world economy that Keynes was able to draw. In bold broad strokes, he described the workings of the prewar Edwardian world, the fragile foundations on which it had been built, and the mutilation to its financial fabric left by the war. He gave a foreboding picture of the future as the forces that had sustained the old economic order began to come asunder. Sounding at times like an Old Testament jeremiad, the book spoke of "civilization under threat," of "men driven by starvation to the nervous instability of hysteria and mad despair." The tone of impending doom may seem overwrought to our ears, but to a generation that had just emerged from the most horrendous and apparently pointless apocalypse, it rang true.

THE ECONOMIC CONSEQUENCES had an enormous impact on thinking about reparations throughout the world. The biggest change occurred in Britain. Even before the Peace Conference had adjourned in June 1919, Lloyd George had already begun to have second thoughts about the treaty. At the eleventh hour, he even tried to convince the other two leaders that perhaps they should soften the terms, but Wilson had adamantly refused, saying that the prime minister "ought to have been rational to begin with, and then would not have needed to have funked at the end." It was not simply Lloyd George's guilty conscience that led to the British change of heart. Britain, that nation of shopkeepers keen to get back to business, rediscovered the economic centrality of Germany. As foreign minister, Lord Curzon announced to the cabinet, Germany "is to us the most important country in Europe." France, however, clung resolutely to its implacable hostility to its ancient enemy, and with the United States out of the European picture and Britain increasingly sympathetic to Germany, it found itself isolated. ECONOMIC CONSEQUENCES had an enormous impact on thinking about reparations throughout the world. The biggest change occurred in Britain. Even before the Peace Conference had adjourned in June 1919, Lloyd George had already begun to have second thoughts about the treaty. At the eleventh hour, he even tried to convince the other two leaders that perhaps they should soften the terms, but Wilson had adamantly refused, saying that the prime minister "ought to have been rational to begin with, and then would not have needed to have funked at the end." It was not simply Lloyd George's guilty conscience that led to the British change of heart. Britain, that nation of shopkeepers keen to get back to business, rediscovered the economic centrality of Germany. As foreign minister, Lord Curzon announced to the cabinet, Germany "is to us the most important country in Europe." France, however, clung resolutely to its implacable hostility to its ancient enemy, and with the United States out of the European picture and Britain increasingly sympathetic to Germany, it found itself isolated.

In the four years after the Peace Conference, from early 1919 until the end of 1922, Europe was treated to the spectacle of one international gathering after another devoted to reparations. With governments in both France and Germany constantly falling-during those four years France went through five and Germany six-the one constant fixture at all these gatherings was the British prime minister, Lloyd George. As if trying to make up for his failure in Paris, he threw himself into the process. By one calculation, he attended thirty-three different international conferences in those few years. So many of them were held in the gambling resorts and spas of Europe-at San Remo in April 1920, in Boulogne in June, at Wiesbaden in October 1921, at Cannes in January 1922, and the final "circus" at Genoa in April 1922-that the French prime minister, Raymond Poincare, dismissed them as "la politique des casinos. "la politique des casinos."

For all the magnificent and luxurious settings, these gatherings were painful affairs, not least because the French were so unclear in their own minds what they wanted. As Poincare said in June 1922, "As far as I am concerned it would pain me if Germany were to pay; then we should have to evacuate the Rhineland. Which do you regard as better, obtaining cash or acquiring new territory? I for my part prefer occupation and conquest to the money of reparations." Or as Lloyd George more pithily put it, "France could not decide whether it wanted to make beef-stew or milk the German cow."

All the age-old animosities between the British and the French, buried for a decade under the common purpose of confronting Germany, resurfaced. The old stereotypes of the French-those "vainglorious, quarrelsome, restless and over-sensitive" people-on which previous generations of Englishmen had been reared, were revived. Foreign Minister Curzon complained of the French proclivity for "the gratification of private, generally monetary, and often sordid interests or ambitions, only too frequently pursued with a disregard of ordinary rules of straightforward and loyal dealing which is repugnant and offensive to normal British instincts." At one point, in 1922, he became so frustrated in a confrontation with French Prime Minister Poincare that he collapsed in tears, crying, "I can't bear him."

Dealing with Germany was no easier. Before the war, an American journalist had remarked on that "uneasy vanity, that touchiness that has made Germany the despair of all the diplomats all over the world." The initial outrage over the Versailles Diktat had now curdled into frustration, bitterness, and resentment, which only made the defeated nation more difficult to deal with. From that first moment in May 1919, when the German foreign minister, Count Ulrich Graf von Brockdorff-Rantzau had insulted the Allied statesmen at Versailles by refusing to stand while addressing them, the Germans caused offense by their arrogant demeanor.

It was not simply their bad manners. They calculated, very correctly, that the longer they could string out the bargaining over reparations, the less they would end up paying. Their whole strategy was therefore to negotiate in bad faith. In the first two years after signing the treaty, Germany desperately sc.r.a.ped together what it could, and paid $2 billion out of the $5 billion of interim payments due.

Meanwhile, the Reparations Commission, established in Paris in mid- 1920, finally put a figure of $33 billion on the table as its estimate of the amount Germany should pay. The Germans responded by subjecting this figure to a series of adjustments to take into account what they had already paid-so transparently bogus as to embarra.s.s even its own representatives in Paris-and concluded this meant they now owed the Allies just $7.5 billion, provoking Lloyd George to say that if the discussions continued any further in this vein, Germany would soon be claiming reparations from the Allies.

In May 1921, British Treasury officials developed a proposal that they believed to be so reasonable that Germany would find it difficult to turn down. The reparations bill was to be set at the equivalent of $12.5 billion, roughly 100 percent of the German prewar GDP. To meet the annual interest and princ.i.p.al repayments on this new debt, Germany was required to pay between $600 million and $800 million, a little over 5 percent of its annual GDP.

In May 1921, the British proposal was accepted at a conference in London. It seemed as if agreement had finally been reached. The German delegation, led by Foreign Minister Walter Rathenau, made much of the new departure in policy. Henceforth Germany would abandon its resistance to the terms of the treaty, and instead would adopt a policy of "fulfillment."

The problem was that the Germans never really believed that they could meet even this commitment. Despite the fact that the new reparations bill was now closer to the amounts originally proposed by liberal commentators such as Keynes, German officials remained convinced that even $12.5 billion of reparations would prove an intolerable burden. As a consequence, they made no real effort to meet the terms of the London schedule. They paid on schedule just once. Within six months of the London settlement, they were in arrears and back before the Reparations Commission, pleading for a moratorium. Of the $1.2 billion that Germany owed during the first eighteen months of the schedule, it paid little more than half.

WHILE GERMANY WAS grimly trying to negotiate relief from the burden of reparations, its domestic economic policy, bad as it had been during the war, became worse. The country was in perpetual turmoil, constantly on the brink of revolution, run by a series of weak coalition governments, and was quite unable to control its finances. In addition to large residual expenses from the war-pensions to veterans and war widows, compensation for those who had lost private property in the territories forfeited under the Treaty of Versailles-the governments took on enormous new social obligations: an eight-hour day for workers, insurance for the unemployed, health and welfare payments for the sick and the poor. Germany's financial problems were mostly self-inflicted. Nevertheless, reparation payments made what was already a difficult fiscal situation impossible. To finance the gap, the various governments of Germany resorted to the Reichsbank to print the money.

In 1914, the mark stood at 4.2 to the dollar, meaning that a mark was worth a little under 24 cents. By the beginning of 1920, after the full effects of the inflationary war finance had worked through the system, there were 65 marks to the dollar-the mark was now worth only 1.5 cents-and the price level stood at nine times its 1914 level. Over the next eighteen months, despite an enormous budget deficit and a 50 percent increase in the amount of currency outstanding, inflation actually slowed down and the mark even stabilized. Foreign private speculators, betting that the mark had fallen too far, moved some $2 billion into the country. After all, this was Germany, not unjustly viewed before the war as the epitome of discipline, orderliness, and organization. It seemed inconceivable that it would allow itself to sink into an orgy of monetary self-abas.e.m.e.nt and give up on restoring order.

"Nothing like this has been known in the history of speculation," wrote Maynard Keynes. "Bankers and servant girls have been equally involved. Everyone in Europe and America has bought mark notes. They have been hawked . . . in the streets of the capitals and handled by barbers' a.s.sistants in the remotest townships of Spain and South America."

A series of events, however, in the middle of 1921-French inflexibility over reparations, a campaign of political murder by right-wing death squads-broke the public's confidence that Germany's problems were soluble. It abandoned the mark in droves.The foreign speculators who had bought marks the previous two years also bailed out, losing most of the $2 billion they had pumped in. A visitor in the late 1920s to the game rooms of Milwaukee or Chicago would find the walls papered with German currency and bonds that had become worthless.

As the mark plummeted, Germany became caught in an ever-deepening downward spiral. On June 24, 1922, the architect of fulfillment, Foreign Minister Walter Rathenau, one of the most attractive political figures in Germany-cultured, rich, scion of a great industrial family-was gunned down in his car by yet another group of crazed reactionaries. Panic set in. Prices rose fortyfold during 1922 and the mark correspondingly fell from 190 to 7,600 to the dollar.

In early 1923, when Germany was late in meeting a reparations payment for that year-the precipitating incident was the failure to deliver one hundred thousand telephone poles to France-forty thousand French and Belgian troops invaded Germany and occupied the Ruhr valley, its industrial heartland. The chancellor, Wilhelm Cuno, powerless in every other way, launched a campaign of pa.s.sive resistance. The budget deficit almost doubled, to around $1.5 billion. To finance this shortfall required the printing of ever-increasing amounts of ever more worthless paper marks. In 1922, around 1 trillion marks of additional currency was issued; in the first six months of 1923 it was 17 trillion marks.

Wrote one observer: "In the whole course of history, no dog has run after its own tail with the speed of the Reichsbank. The discredit the Germans throw on their own notes increases even faster than the volumes of notes in circulation. The effect is greater than the cause. The tail goes faster than the dog."

The task of keeping Germany adequately supplied with currency notes became a major logistical operation involving "133 printing works with 1783 machines . . . and more than 30 paper mills." By 1923, the inflation had acquired a momentum of its own, creating an ever-accelerating appet.i.te for currency that the Reichsbank, even after conscripting private printers, could not meet. In a country already flooded with paper, there were even complaints of a shortage of money in munic.i.p.alities, so towns and private companies began to print their own notes.

Over the next few months, Germany experienced the single greatest destruction of monetary value in human history. By August 1923, a dollar was worth 620,000 marks and by early November 1923, 630 billion.17 Basic necessities were now priced in the billions-a kilo of b.u.t.ter cost 250 billion; a kilo of bacon 180 billion; a simple ride on a Berlin street car, which had cost 1 mark before the war, was now set at 15 billion. Even though currency notes were available in denominations of up to 100 billion marks, it took whole sheaves to pay for anything. The country was awash with currency notes, carried around in bags, in wheelbarrows, in laundry baskets and hampers, even in baby carriages.

It was not simply the extraordinary numbers involved; it was the dizzying speed at which prices were now soaring. In the last three weeks of October, they rose ten thousandfold, doubling every couple of days. In the time that it took to drink a cup of coffee in one of Berlin's many cafes the price might have doubled. Money received at the beginning of the week lost nine-tenths of its buying power by the end of the week.

It became meaningless to talk about the price of anything, because the numbers changed so fast. Economic existence became a race. Workers, once paid weekly, were now paid daily with large stacks of notes. Every morning big trucks loaded with laundry baskets full of notes rolled out of the Reichsbank printing offices and drove from factory to factory, where someone would clamber aboard to pitch great bundles to the sullen crowds of workers, who would then be given half an hour off to rush out and buy something before the money became worthless. They grabbed almost anything in the shop to barter later on for necessities in the flea markets, which had sprung up around the city.

Having to calculate and recalculate prices in the billions and trillions made any sort of reasonable commercial calculations almost impossible. German physicians even diagnosed a strange malady that swept the country, which they named "cipher stroke." Those afflicted were apparently normal in every respect except, according to the New York Times, New York Times, "for a desire to write endless rows of ciphers and engage in computations more involved than the most difficult problems in logarithms." Perfectly sensible people would say they were ten billion years old or had forty trillion children. Apparently cashiers, bookkeepers, and bankers were particularly p.r.o.ne to this bizarre disease. Most people simply turned to barter or to using foreign currency. Every middle-cla.s.s housewife knew up to the latest hour the exchange rate for the mark against the dollar. At every street corner, in shops and tobacconists', even in apartment blocks, minute "for a desire to write endless rows of ciphers and engage in computations more involved than the most difficult problems in logarithms." Perfectly sensible people would say they were ten billion years old or had forty trillion children. Apparently cashiers, bookkeepers, and bankers were particularly p.r.o.ne to this bizarre disease. Most people simply turned to barter or to using foreign currency. Every middle-cla.s.s housewife knew up to the latest hour the exchange rate for the mark against the dollar. At every street corner, in shops and tobacconists', even in apartment blocks, minute bureaux de change bureaux de change sprang up, with blackboards outside, advertising the latest exchange rates. sprang up, with blackboards outside, advertising the latest exchange rates.

With the mark falling faster than domestic prices were rising, foreigners were able to live grotesquely well. Berlin apartments worth $10,000 before the war could be bought for as little as $500. Malcolm Cowley, an American literary critic then living in Paris, in Berlin to visit his friend the journalist Matthew Josephson, wrote, "For a salary of a hundred dollars a month, Josephson lived in a duplex apartment with two maids, riding lessons for his wife, dinners only in the most expensive restaurants, tips to the orchestra, pictures collected, charities to struggling German writers-it was an insane life for foreigners in Berlin and n.o.body could be happy there." For one hundred dollars, a Texan hired the full Berlin Philharmonic for an evening. The contrast between the extravagance of foreigners, many of them French or British, but also Poles, Czechs, and Swiss, and the daily struggles of the average German to make a living only fed the resentment against the Versailles settlement further.

Inflation transformed the cla.s.s structure of Germany far more than any revolution might have done. The rich industrialists did well. Their large holdings of real a.s.sets-factories, land, stocks of goods-soared in value while inflation wiped away their debts. Workers, particularly the unionized, also did surprisingly well. Until 1922, their wages kept up with inflation and jobs were plentiful. It was only in the last stages, from the end of 1922 into 1923, when the implosion of confidence caused the monetary system to seize up and the economy reverted to barter, that men were thrown out of work.

Those who made up the backbone of Germany-the civil servants, doctors, teachers, and professors-were hit the worst. Their investments in government bonds and bank deposits, carefully acc.u.mulated after a lifetime of prudence and discipline, were suddenly worthless. Forced to sc.r.a.pe by on meager pensions and salaries, which were decimated by inflation, they had to abandon their last vestiges of dignity. Imperial officers took jobs as bank clerks, middle-cla.s.s families took in lodgers, professors begged on the streets, and young ladies from respectable families became prost.i.tutes.

The people who truly raked it in were the speculators. By buying up a.s.sets-houses, jewelry, paintings, furniture-at throwaway prices from middle-cla.s.s families desperate for cash, by cornering the market in goods that were in scarce supply, profiteering in imported commodities and gambling on a further collapse in the currency, they enriched themselves beyond their wildest dreams.

As German society was overturned, the traditional values that had made it so conservative and ordered a community were jettisoned. Stefan Zweig, the writer, tried to capture the mood of that time in his autobiography: "How wild, anarchic, and unreal were those years, years in which, with the dwindling value of money, all other values in Austria and Germany began to slip. It was an epoch of high ecstasy and ugly scheming, a singular mixture of unrest and fanaticism. Every extravagant idea . . . reaped a gold harvest."

THE OFFICIAL MOST responsible for the reckless policy of inflation was none other than Rudolf von Havenstein, the sober and dedicated president of the Reichsbank who had so disastrously overseen Germany's wartime finances. When the war ended in disaster, Von Havenstein fully expected to lose his job. A Prussian official closely identified with the imperial administration, he did not conceal his lack of sympathy for the new government led by the Social Democrats. Nevertheless, during the revolution of 1918, he went out of his way to cooperate with it, even allowing one of the new workers' and soldiers' councils to form within the Reichsbank. During those days of violence and turmoil, he also used a squad of revolutionary sailors to guard the Reichsbank's gold reserves to convey the message that it was the "people" who controlled the nation's treasure, though the word was that he had secretly b.o.o.by-trapped the safes with poison gas just in case the sailors' loyalty wore thin.

Having successfully maneuvered to keep his job, Von Havenstein found himself in the cla.s.sic dilemma of the dutiful civil servant. He was now working for a government for which he had little liking, one that was pursuing a social agenda he did not believe in and thought Germany could ill afford. Worst of all, the government had decided to make its best efforts to pay the Allies' demands-the so-called policy of fulfillment. Nevertheless, despite these fundamental disagreements, Von Havenstein acceded to the government's requests and allowed the Reichsbank to print money to finance the budget gap.

Why did Von Havenstein submit without any apparent effort to resist? Two very conflicting pictures have been drawn of his motives: that he deliberately engineered the whole monetary explosion as a way of destroying the financial fabric of Germany, a collective self-immolation designed to prove to the Allies that reparations were uncollectible, or alternatively, that his conduct reflects nothing subtler than sheer economic ignorance. Trained as a lawyer, he had learned the banking business during the gold standard era, when the rules of monetary policy were dictated by the requirement that the Reichsmark be kept convertible at a fixed gold equivalent, and was completely at sea in a world not hitched to gold.

The truth seems to be more complex than either explanation. Von Havenstein faced a very real dilemma. Were he to refuse to print the money necessary to finance the deficit, he risked causing a sharp rise in interest rates as the government scrambled to borrow from every source. The ma.s.s unemployment that would ensue, he believed, would bring on a domestic economic and political crisis, which in Germany's current fragile state might precipitate a real political convulsion. As the prominent Hamburg banker Max Warburg, a member of the Reichsbank's board of directors, put it, the dilemma was "whether one wished to stop the inflation and trigger the revolution" or continue to print money. Loyal servant of the state that he was, Von Havenstein had no wish to destroy the last vestiges of the old order.

Alternatively, if by standing firm against the government he forced it to raise taxes or cut domestic expenditures, he would be accused, particularly by his nationalist friends on the right, of being a tool of the blood-sucking Allies, who all along had been insisting that Germany could pay reparations if it would only cut its domestic expenditures and raise taxes. In effect, Von Havenstein would be in the position of doing the Allies' dirty work-he just could not bring himself to act as the collection agent for his country's enemies.

Faced with these confusing and competing considerations, Von Havenstein decided to play for time, supplying the government with whatever money it needed. Contrary to popular myth, he was perfectly aware that printing money to finance the deficit would bring on inflation. But he hoped that it would be modest, and that in the meantime, something would turn up to induce the Allies to lower their demands or at least agree to a moratorium on actual payments, giving Germany some breathing s.p.a.ce.

It was a total miscalculation. Von Havenstein failed to recognize that experimenting with the currency was like walking a knife-edge. A moderate degree of inflation does not remain moderate for long. At some point the public loses confidence in the authority's power to maintain the value of money, and deserts the currency in panic. Germany pa.s.sed this tipping point in the middle of 1921.

Instead of admitting that he had made a terrible mistake, Von Havenstein, with his dogged Prussian sense of duty, dug in his heels, refusing to change any of his policies and continuing to print as much money as the government "needed." The inflation had initially been beneficial to private business because it had the effect of wiping out their debts. By 1923, however, the crisis had moved to a new stage, and without a functioning currency, commerce became impossible. Unemployment, which had hovered around 3 percent suddenly shot up to 20 percent in the fall of 1923. In order to maintain some illusion of solvency, Von Havenstein began to pump Reichsbank money directly to private businesses. He hid behind the claim that, but for reparations, there would be no inflation in Germany and therefore put the blame for the inflation on the rapacious demands of foreigners. He began arguing that the inflation had nothing to do with him, that he was a pa.s.sive bystander to the whole process, that his task was simply to make enough money available to grease the wheels of commerce, and if business required a trillion more marks, then it was his job to make sure they were run off the presses and efficiently distributed around the country.

On August 17, 1923, he delivered his annual report on economic conditions before the Council of State: The Reichsbank today issues 20,000 milliard marks of new money daily, of which 5,000 milliards are in large denominations. In the next week the bank will have increased this to 46,000 milliards daily, of which 18,000 milliards will be in large denominations. The total issue at present amounts to 63,000 milliards. In a few days we shall therefore be able to issue in one day two-thirds of the total circulation.

Here was the president of the Reichsbank, whose princ.i.p.al obligation was supposed be the preservation of the value of the currency, proudly proclaiming to a group of parliamentarians that he now had the capacity to expand the money supply by over 60 percent in a single day and flood the country with even more paper. For many people, it was just one more sign that German finance had entered an Alice-in-Wonderland phantasmagoria.

"No-one could antic.i.p.ate such an ingenious revelation of extreme folly to which ignorance and false theory could lead . . . The Reichbank's own demented inspirations give stabilization no chance," wrote the British amba.s.sador, Lord d'Abernon, an expert on state bankruptcies who had thought that he surely had to have witnessed the worst financial excesses in the lunacies of the Egyptian khedives and the Ottoman Turks, only to find them almost Swiss in their rect.i.tude compared to the Germany of 1923. "It appears almost impossible to hope for the recovery of a country where such things are possible. It is certainly vain to hope for it unless power is taken entirely from the lunatics presently in charge."

WHEN THE WAR ENDED, Hjalmar Schacht was just a modestly successful banker, not yet especially distinguished or rich. It was the opportunities thrown up by inflation that would make him powerful and wealthy. He certainly did not make money by speculating himself-having grown up poor, he was very conservative and took few risks with his own savings. He was, however, lucky.

In 1918, he recruited a thirty-six-year-old stockbroker, Jacob Goldschmidt, to join the Nationalbank. Goldschmidt was talented, cultivated, and charming, very different from the traditional conservative bankers of Berlin, a self-made millionaire who had built a successful stock exchange trading firm. Once at the Nationalbank, Goldschmidt began playing the market with large amounts of the bank's capital, and by engineering a series of astute mergers, he transformed the bank, now named the Danatbank, into the third largest banking conglomerate in Germany. By 1923, Schacht had suddenly been vaulted into the upper reaches of the Berlin banking establishment.

In the summer of 1923, he stood at his office window contemplating the scene below. While most of the other large Berlin banks were housed along the Behrenstra.s.se in somber gray buildings with great rusticated stone walls and ma.s.sive pillars and pilasters, the Danatbank had chosen for its headquarters a charming red sandstone building overlooking a quiet square on the banks of the Spree. His own office commanded a perfect view of the square below, in the center of which stood a small bronze statue of Karl Friedrich Sc.h.i.n.kel, the architect who had designed so much of Berlin-a strangely tranquil scene, he reflected, far removed from the fever gripping the rest of the city.

A constant reminder of what had happened to Germany loomed eastward across the ca.n.a.l: the Berliner Schloss, for almost five centuries the home of the Hohenzollern kings. The vast imperial palace of over 1,200 rooms, its grand dome dominating the landscape for miles, now stood empty, its contents looted and ransacked, its beautiful balconies splintered and shattered, its Baroque facade disfigured by large pallid patches where artillery sh.e.l.ls had struck during the 1918 revolution.

Schacht had become increasingly ambivalent about the new republican Germany. In no way nostalgic about the past, he felt no regret at the pa.s.sing of empire, with its "old style Prussian militarism" that sought to impose a "permanent order of society." But proud and nationalistic as he was, he did look back to the times before the war when Germany had been a nation of order and discipline, the economic powerhouse of Europe. The country was, in his view, now destroying itself pointlessly. The republic had betrayed the professional middle cla.s.ses, which had once made Germany so strong. The Fatherland had become a "h.e.l.l's kitchen."

Though he now had the money and position he had so long scrambled to acquire, Schacht felt frustrated. At the Danatbank, he had been sidelined by the more successful Goldschmidt. By writing articles in the Berliner Tageblatt Berliner Tageblatt and the and the Vossische Zeitung Vossische Zeitung, he had developed something of a reputation as an expert on reparations, arguing that Germany could and should pay no more than $200 million a year, equivalent to a total reparations settlement of $4 billion, a third of what had been agreed to in London in 1921. It was an amount that at the time would have been completely unacceptable to France. He tried to have it both ways. At the same time he was taking a hard line on the level of reparations that Germany could pay, he would urge the government to be more pragmatic, to open negotiations with the French, abandon the failed policy of pa.s.sive resistance in the Ruhr, and cease printing money.

Had he been honest with himself, he would have had to admit that he was lucky not to have been involved. Over the last three years, as the country had sunk into economic chaos, reparations had been a no-win issue for any German politician or official.

8. UNCLE SHYLOCK.

War Debts Neither a borrower, nor a lender be; for loan oft loses both itself and friend.

-WILLIAM SHAKESPEARE, Hamlet

THE problem of collecting reparations from Germany was made infinitely more complex by that of war debts owed to the United States. Britain had gone to war as "the world's banker," controlling over $20 billion in foreign investments. No other financial center-neither Berlin nor Paris, certainly not New York-came close to matching London's standing as the hub of international finance. Through it pa.s.sed two-thirds of the trade credit that kept goods flowing around the globe and half the world's long-term investments-over $500 million a year. Meanwhile, France, though never so dominant a financial power, had its own overseas portfolio of $9 billion, of which an astounding $5 billion was invested in Russia.

To pay for the four long, destructive years just past, every country in Europe had tried to borrow as much as it could from wherever it could. The effect was to create a seismic shift in the flow of capital around the world. Both Britain and France were forced to liquidate a huge proportion of their holdings abroad to pay for essential imports of raw materials, and both eventually resorted to large-scale borrowing from the United States. By the end of the war, the European allied powers-sixteen countries in all-owed the United States about $12 billion, of which a little under $5 billion was due from Britain and $4 billion from France. In its own turn, Britain was owed some $11 billion by seventeen countries, $3 billion of it by France and $2.5 billion by Russia, a debt essentially uncollectible after the Bolshevik revolution.

At an early stage of the Paris Peace Conference, both the British and the French tried to link reparations to their war debts, indicating that they might be prepared to moderate their demands for reparations if the United States would forgive some of what they owed America. The United States reacted strongly, insisting that the two issues were separate. Its delegates, many of them lawyers, including the secretary of state, Robert Lansing, made a clear moral and legal distinction between reparations, which resembled a fine and were intended to be punitive, and war debts, which were contractual liabilities voluntarily entered into by the European Allies. The Europeans, less wedded to legal modes of thought, failed to see either the moral or the practical distinction between their obligations to the United States and Germany's obligations to them. Both would be burdensome and both would require material sacrifice for several generations.

As the Peace Conference was winding to its end, Maynard Keynes, distressed at how the negotiations were going, decided on his own initiative to put together a comprehensive plan for the financial reconstruction of Europe. Reparations should be fixed at $5 billion, to be paid by Germany in the form of long-term bonds issued to the Allies, which they would in turn a.s.sign to pay their war debts to the U.S government. All other obligations were to be forgiven. It was a clever scheme. The U.S. government would be functionally lending Germany money, which in turn would go to pay reparations to the Allies, who in turn would use those proceeds to settle their loans. The money would start in a United States flush with gold, and eventually return there full circle.

Keynes pa.s.sed the plan on to the chancellor of the exchequer, Austen Chamberlain, who in turn recommended it to Lloyd George. The prime minister received Keynes's plan just as he was beginning to realize the extent of his tactical errors over reparations and, in a short burst of enthusiasm, submitted it to President Wilson. It was rejected out of hand by the American delegates, who continued to insist that war debts must not be linked to reparations and that the former could not be forgiven on such a scale. And thus the problem of reparations and war debts would be allowed to fester over the maimed economic body of Europe.

TEN DAYS AFTER the armistice of November 11, 1918, Benjamin Strong wrote to Montagu Norman, "The princ.i.p.al danger now ahead of us . . . is not social and political unrest" but that the coming peace negotiations would "develop along lines of economic strife" that would lead to "a period of economic barbarism which will menace our prosperity." "There is no doubt," he continued, "that much of the world's happiness in the future will depend upon the relations now being established between your country and ours." Over the next decade that compact between Britain and the United States-or rather between the Bank of England and the Federal Reserve-built upon the friendship between Norman and Strong, would be one of the fixed points of the world's financial architecture.

The two of them came to that compact from very different directions. For Norman, it was a matter of simple necessity. The war had devastated Britain economically; and, he believed, only by acting in conjunction with the Americans could Britain hope to regain its old financial influence. For Strong, the calculation was a little more complicated. As a banker from the Morgan fold, he was naturally an internationalist. The war had brought a new recognition among U.S. financiers that the fate of their country was inextricably linked to that of Europe. Now, with the arrival of peace, he believed that it was in its own interest for the United States to use some of its huge resources to "help to rebuild a devastated Europe."

There was also a moral imperative to Strong's internationalism. He was part of that generation of Americans who, having begun their careers under Theodore Roosevelt and having reached maturity under Woodrow Wilson, viewed themselves and their country as now uniquely qualified and positioned, by virtue of money and ideas, to transform the conduct of international affairs. He was, of course, not so naive that he did not recognize that many Europeans remained cynical about U.S. motives-accusing it, for example, of having deliberately waited until Europe had come close to bankruptcy before entering the war. He, however, was one of those who believed that now that the war was over, his nation had a unique opportunity to show that it was truly, in his own words, an unusually "unselfish, generous people."

He was especially influenced in his sense of high purpose about America's world mission by a group of young men with whom he had become friends who went by the mysterious name "The Family." Based in Washington, The Family was an exclusive private club, which he had been invited to join before the war. It had no official name, was indeed not really a club at all-no officers, no charter, no formal membership roll. It had come into being in 1902 when three young army officers, captains Frank McCoy, Sherwood Cheney, and James Logan, all in their early thirties, attracted to Washington by Theodore Roosevelt's "call to youth," decided to rent a house together at 1718 H Street. This soon became a gathering spot for ambitious young diplomats and service officers, all similarly inspired by Roosevelt's vision of a muscular U.S. foreign policy. In the absence of a formal name, it came to be known as the 1718 Club or The Family.18 The membership progressively widened to include a more eclectic circle, including journalists, such as Arthur Page, editor of the popular monthly The World 's Work; The World 's Work; politicians, like Congressman Andrew Peters, who would become mayor of Boston; and bankers, such as Strong. Over the years, though, The Family had remained an extraordinarily tight-knit group who kept in close touch with one another, particularly during the war. When the fighting finally stopped, many members found themselves thrown into the peace negotiations. politicians, like Congressman Andrew Peters, who would become mayor of Boston; and bankers, such as Strong. Over the years, though, The Family had remained an extraordinarily tight-knit group who kept in close touch with one another, particularly during the war. When the fighting finally stopped, many members found themselves thrown into the peace negotiations.

No one was more emblematic of the ethos of The Family than Willard Straight, a flamboyant charmer whose life reads like something out of a boy's adventure novel. Early orphaned, Straight had graduated from Cornell, gone out to China, where he learned Mandarin, served as a reporter during the Russo-j.a.panese war of 1904, become secretary to the American legation in Korea, been appointed consul general in Manchuria, and joined a Morgan-led bank in China, all by the age of thirty. Thereafter he had married an heiress, Dorothy Whitney; helped found the New Republic; New Republic; seen army service in France; and with the armistice, joined the advance team in Paris to prepare for the forthcoming Peace Conference. Tragically, he contracted influenza during the 1918 pandemic and died suddenly in December 1918, at the age of thirty-eight. seen army service in France; and with the armistice, joined the advance team in Paris to prepare for the forthcoming Peace Conference. Tragically, he contracted influenza during the 1918 pandemic and died suddenly in December 1918, at the age of thirty-eight.

Another member, Joseph Grew, had been in Germany as the number two in the emba.s.sy during the first years of the war, had gone on to become the State Department's desk officer for Germany, and was now leading the advance team in Paris. William Phillips, who came from a rich family and had rejected a "pallid career" in business to become a career foreign service officer, became a Far Eastern specialist after a.s.signment to Peking. Subsequently posted to London, he was now an a.s.sistant secretary of state. Another foreign service hand, Basil Miles, a particularly close friend of Strong's, had taken his degree at Oxford, been posted to Petrograd in 1914, and was now State's prime expert on Russia.

James Logan, one of the founders of this dedicated brotherhood, had stayed in the army, rising to the rank of lieutenant colonel, and had been posted to France in 1914 as chief of the American observer military mission. An overweight bon viveur, bon viveur, he had become a fixture in Paris. Once the United States joined the war, he was given a high staff position in the American Expeditionary Force and was now working for Herbert Hoover in the Relief Administration. he had become a fixture in Paris. Once the United States joined the war, he was given a high staff position in the American Expeditionary Force and was now working for Herbert Hoover in the Relief Administration.

With so many fellow members of The Family in Paris in the war's immediate aftermath, Strong decided that he should see for himself what needed to be done in Europe. But as happened so often over the next few years, his body gave out on him. Worn out by the demands of war finance, he suffered a minor recurrence of tuberculosis and was forced to take another leave of absence during the first few months of 1919.

By the summer, he was back on his feet and ready to go to Europe. The Peace Conference had just finished, and as he left the United States the country was still in the full flush of jubilation and optimism over the signing of the peace treaty. Strong arrived in England on July 21, aboard R.M.S. Baltic Baltic, as Britain's official peace celebrations were winding down. There had been parades and ceremonies across the country from the tiniest villages to the biggest cities. In London a million people had come out to watch a huge parade, including American and French contingents led by General John Joseph "Black Jack" Pershing and Marshal Ferdinand Foch, march past the king and queen and members of the government. The capital was still decked out with flags, and the troops who had taken part were still camped out in Kensington Gardens as Strong's train rolled into the city.

Although the statesmen in Paris had failed to come up with some grand initiative to reconstruct Europe, he arrived full of great expectations, still convinced, for all the failures of the treaty, that the United States would eventually adopt a "constructive policy towards the restoration of Europe," by postponing the repayment of war debts and providing direct aid for reconstruction.

For all the celebrations, he found the city's mood ominously changed. In contrast to America, Britain was only slowly readjusting to peace. Tobacco restrictions had been removed in January and most food rationing in May. But bread was still obtainable only with ration coupons, as was sugar. The initial optimism, which had gripped Britain and all the European victors immediately after the war, was now wearing off as the grim realities of Britain's underlying position were becoming steadily more apparent. The war had changed the balance of financial power, and Strong kept encountering a festering resentment against the United States, especially over war debts.

Few people in those days thought in terms of a "special relationship" between Britain and the United States-indeed, the phrase was only coined in 1945 by Winston Churchill. Before the war, most London bankers viewed their counterparts in the United States with that superciliousness reserved for unsophisticated kinsmen, too rich for their own good. Within the United States, certain circles-the House of Morgan, the partners at Brown Brothers-were natural Anglophiles. Elsewhere, Britain was generally regarded with suspicion and cynicism. But during the war and after, British arrogance had given way to resentment. London bankers worried that the United States, with its newly acquired financial muscle, was getting ready to elbow its way into the role of banker to the world. During Strong's visit to London in March 1916, he attended a speech made by Sir Edward Holden, chairman of the London City and Midland Bank, "in which [Sir Edward] referred to efforts of American bankers to undermine Lombard Street's supremacy and . . . was so overcome by the mere thought that the old man broke down and wept."

Strong now found British bankers and politicians fervently convinced "that the Allies have made the greatest and most vital sacrifice in the war" while the U.S. sacrifices had "been slight, and our profits immense and that existence of this great debt is a sword of Damocles hanging over their heads." There was considerable bitterness at how long the United States had sat out the war, many of Strong's English acquaintances believing that America had deliberately waited for Europe to wear itself out before stepping in to pick up the pieces. Now those same people argued that the U.S. government was morally obliged to forgive part of their European Allies' war debts. This was especially true in Britain, which had borrowed some $5 billion from the United States but had itself lent $11 billion to France, Russia, and other countries-in effect, simply acting as a conduit for the loans. And though his friend Norman tried to rea.s.sure him that people were allowing "their hearts to rule their heads," that Britain's credit was still strong, and that it was still good for its debts, Strong was undoubtedly shaken by the pessimism that hung over the City of London.

Not only had Britain's place in the world changed, but British society had also been transformed by the war. The aristocracy that had ruled Britain for much of the previous century had been badly damaged-as one contemporary author wrote, albeit with some exaggeration, "In the useless slaughter of the Guards on the Somme, or of the Rifle Brigade in Hooge Wood, half the great families, heirs of large estates and wealth, perished without a cry." After enduring savage losses in the fighting-the casualty rate had been three times heavier among junior officers, many of them aristocrats, than among enlisted men-the old elite had also been hurt by the wartime inflation and was now being decimated by postwar economic dislocations. Land prices had collapsed and many large estates been put up for auction. In place of the old and confident ruling cla.s.s, a whole new breed-"hard-faced men who had looked as if they had done well out of the war," as one eminent politician described his new colleagues in the House of Commons-had come to power.

At the end of July, Strong went on to Paris and, for the next few weeks, used the Ritz Hotel on the Place Vendome as his base while traveling around Europe. He visited Brussels-liberated only a few months before-Antwerp, and Amsterdam, establishing connections with the heads of European central banks but also taking a melancholy motoring trip through the giant cemeteries of the Western Front.

The view from Paris was even more foreboding than from London. The city was dark by 10:00 p.m. for want of coal to generate electricity. The Peace Conference was still officially in session, limping through the final negotiations with the smaller Central Powers and successor states: Austria, Hungary, Bulgaria, and Turkey. But the big delegations had all departed and with them the accompanying train of ten thousand other a.s.sorted people: the advisers, the wives, the mistresses, the cooks, drivers, messengers, secretaries, and journalists. The hotels had reverted to their normal business-at the end of July, the Majestic, headquarters of the British delegation during the conference, and the Crillon, that of the American delegation, both reopened for commercial business. The radical journalist Lincoln Steffens, who had come to Paris with the American delegation and stayed on after the conference, best captured the city's bitter mood of disillusionment during those months, "The consequences of the peace were visible from Paris. There were wars, revolutions, distress everywhere."

Over the summer, the political threats to Europe had actually begun to recede. Though civil war still ravaged Russia, the risk of Bolshevik revolution in Germany had diminished. A Communist uprising in Berlin and an attempted revolution in Bavaria had both been crushed. From Strong's point of view, the main danger was now economic. The two largest countries, France and Germany, both urgently needed food from abroad. Continental Europe was desperately short of capital to rebuild itself. Most disturbingly, he found a complete "lack of leadership" in Europe, with "people in authority . . . exhausted."

While Strong was in Paris, it became apparent that the United States was beginning its retreat from European affairs. The peace treaty had run into trouble in the Senate and seemed headed for defeat. Though the president had announced his intention to appeal directly to the people, the mood of the country was clearly turning isolationist.

Strong could not hide his disgust at this betrayal. At the end of August he warned Russell Leffingwell, undersecretary of the treasury and soon to be a Morgan partner, that if the United States were to "desert Europe and leave these new governments to their fate," this could only result in "prolonged disorder and suffering. It would be an act of cowardice for which we would be despised." He returned to the United States in late September. A few days before, on September 25, the president had collapsed with a stroke on his western campaign to drum up support for the treaty, and for the next year was to lie incapacitated in the White House. On November 19 the Senate rejected the treaty by a vote of 55 to 39.

As so often seemed to happen when he got back from Europe, Strong suffered yet another relapse of his tuberculosis. The doctors again insisted that he take a leave of absence, and the directors of the New York Fed released him for a year. Initially he went out to Arizona for the elevation and dry climate and by the following spring seemed well on the way to recovery. In March he set off on horseback across the Arizona desert accompanied by an unusual troop of companions: a mule skinner c.u.m cook; a Pima Indian guide c.u.m horse wrangler whose name was either Frank, Francisco, Pancho, or Juan-no one was quite sure which-a Russian wolfhound named Peter; and Strong's old friend from The Family, Basil Miles. As this entourage trekked across the wilderness, breathing "the most wonderful air," seeing "the most gorgeous sunsets," and sleeping under the stars, the problems of European reconstruction and currency chaos must have seemed far away.

After Arizona, Strong decided to take advantage of his year off by traveling around the world. Accompanied by his eldest son, Ben, and his friend Miles, he left San Francisco in early April for j.a.pan. They went on to China, the Philippines, Java, Sumatra, Ceylon, India, finally arriving at Ma.r.s.eilles in winter 1920. There Strong found a letter from Montagu Norman awaiting him. "Whenever you do come to London, let me remind you of your hotel, of which the address is 'Thorpe Lodge, Campden Hill, W.8.' The Booking Clerk tells me that an hour's notice will be enough to get your room ready, or, if you are in a hurry, this can be done after you have arrived." While Strong had been traveling, Norman had been elevated to the governorship of the Bank of England. It was the beginning of a true partnership.

If REPARATIONS POISONED the relations among European countries, war debts did the same to the relations between the United States and its erstwhile a.s.sociates, Britain and France. However hard the Americans tried to separate war debts from reparations, in the minds of most Europeans they remained inextricably linked. Indeed, in the middle of 1922, the British government made the connection explicit in a note drafted by Arthur Balfour, then acting foreign secretary, that Britain would collect no more on its loans to its Continental allies and on its share of reparations from Germany than the United States collected from it as payments on its own war debts.