Lords of Finance_ The Bankers Who Broke the World Part 5

The Balfour Note provoked an outcry in the United States. Balfour, an aristocrat and philosopher of some repute-in 1895 he had published a work of great subtlety ent.i.tled The Foundations of Belief The Foundations of Belief-was the elder statesman of British politics, having been prime minister before the war and foreign secretary under Lloyd George. Many were charmed by his urbane gracious manners and his air of bemused detachment-at the Peace Conference a British diplomat remarked that he "makes the whole of Paris seem vulgar." In the United States, however, he was viewed as a "top-hatted frock-coated personification of British decadence," and the tone of condescension and moral superiority adopted in the Note infuriated the Americans. "Lord Balfour seems to think that he can call us sheep thieves in language so elegant that we shall not understand it," wrote one American. According to the Philadelphia Inquirer Philadelphia Inquirer, "In the Balfour Note John Bull is depicted as the liberal, magnanimous and sympathetic creditor whose heart bleeds for his debtors' sufferings, and who is willing and anxious to relieve them of a burden which he perceives is beyond their ability to bear; Uncle Sam is portrayed as a ruthless, relentless, hard-hearted Shylock, who is making it impossible for John Bull to follow his altruistic and benevolent instincts by stubbornly insisting upon the letter of his bond."

To make matters even worse, Congress had decided to get into the act. In March 1922, Congress created the five-man World War Foreign Debt Commission, which was chaired by the secretary of the treasury, Andrew Mellon, and included the secretary of state, Charles Evans Hughes; the secretary of commerce, Herbert Hoover; Senator Reed Smoot of Utah; and Representative Theodore Burton of Ohio. The commission was to negotiate the terms on which American loans were to be repaid. Concerned that the administration might be too lenient on the debtors, Congress imposed a floor on any settlement-the commission would not be permitted to accept anything less than 90 cents on the dollar.

The congressional stipulations on war debts provided the Europeans their turn to express outrage. "Has America which but yesterday we acclaimed for her generosity and her idealism fallen to the role of a Shylock?" exclaimed a French senator in L'eclair. L'eclair. Throughout Europe, newspapers began referring to Uncle Sam openly as "Uncle Shylock." Even the Throughout Europe, newspapers began referring to Uncle Sam openly as "Uncle Shylock." Even the Economist, Economist, by no stretch a populist newspaper, printed a letter signed "Portia" that accused the United States of attempting to "lay a tribute upon those who saved Kansas and Kentucky from the German peril." by no stretch a populist newspaper, printed a letter signed "Portia" that accused the United States of attempting to "lay a tribute upon those who saved Kansas and Kentucky from the German peril."

In October 1922, Lloyd George's government precipitously fell and a new Conservative government under Andrew Bonar Law took office in Britain. The incoming chancellor of the exchequer, Stanley Baldwin, was a practical and sensible businessman who believed strongly in settling one's debts-he was so firm an advocate of this principle that in 1919 he had anonymously donated $700,000 of his own money, a fifth of his net worth, to the government as his contribution to paying off the national debt after the war.19 With the rhetoric on both sides of the Atlantic becoming increasingly overheated, Baldwin decided to open negotiations for a settlement with the Americans, telling them he wanted "to approach the discussion as business men seeking a business solution of what fundamentally is a business problem."

A British delegation, led by Baldwin himself and including as its princ.i.p.al adviser, the governor of the Bank of England, Montagu Norman, set sail for the United States on December 30 aboard the Majestic Majestic. Norman was convinced that it was essential to settle with the Americans if Britain was to reestablish its credit, and reclaim London's position as the world's premier financial center. He had visited the United States in August 1921 and May 1922 to make the rounds of senior administration officials in Washington with Strong, including a secret meeting with the president, Warren Harding, to convince them that the United States should remain engaged in European finance. As a result of this groundwork, of all the British financial officials, Norman had the best firsthand knowledge of U.S. politics and the situation in Washington.

On the stormy Atlantic crossing, which took twice as long as normal because of rough seas, gale-force winds, and fog, Baldwin and Norman became fast friends. Norman was usually suspicious of politicians, claiming somewhat disingenuously to have no political views himself-he bragged that he had never voted. The stolid uncharismatic Baldwin was the quintessential nonpolitician. They would remain lifelong friends, sharing a common taste for the pleasures of silence, of country walks and string quartets. Sir Percy Grigg, a high Treasury official who knew both well, described how "they seemed to understand each other and to communicate without having to exchange more than a few monosyllables."

The American negotiating team was led by Secretary Andrew Mellon. Then in his late sixties, Mellon had been born into a wealthy Pittsburgh family and by the age of forty had independently ama.s.sed a fortune of some $500 million, making him the third richest man in America, after John D. Rockefeller and Henry Ford. Taciturn, cold, and reclusive-his son Paul would compare him to the money-obsessed Soames Forsythe of John Galsworthy's Forsyte Saga Forsyte Saga-Mellon's riches had brought him little happiness. In his forties, he had married a frivolous young English girl of nineteen, who within a few years left him for a social-climbing con artist, dragging him through a scandalous divorce in the process. He now lived in an opulently furnished six-bedroom apartment at 1785 Ma.s.sachusetts Avenue, a block east of Dupont Circle, where his daughter Ailsa, a self-involved and sickly young lady p.r.o.ne to all sorts of psychosomatic ailments, acted as hostess.

The discussions were conducted in great secrecy, some sessions even taking place in Mellon's apartment, surrounded by old masters. There were lunches and dinners-to one such event Vice President Calvin Coolidge, "Silent Cal," was invited and did not utter a word to either of his neighbors during the entire meal. He would later famously dismiss the problem of war debts by exclaiming, "They hired the money, didn't they?" Despite Prohibition, the British delegation was surprised to find an abundance of liquor in private homes.

Before leaving London, they had been given to believe by the American amba.s.sador that they should be able to reach an adjustment of 60 cents on the dollar and the cabinet had not given them the authority to go any higher. Arriving in Washington, they discovered that while the U.S. administration was keen to settle, it was limited by what Congress would accept. After two weeks of negotiations, the best that the Americans could offer was 80 cents on the dollar.

While Baldwin was frustrated by America's lack of generosity-at one point saying that he would like to ship them replicas of the golden calf-Norman pressed him to agree to the terms. In his view, the willingness of the Debt Commission to go beyond the limits set by Congress reflected "a newly found desire on the part of Americans to come into Europe again," and even a stiff settlement was a small price to pay for getting the United States back into European affairs.

On the way home, the British team pa.s.sed through New York. Strong and the Morgan partners advised them that they would not get a better deal by waiting and urged them to settle. Arriving in Southampton on January 27, 1923, Baldwin made the foolish mistake of revealing the terms to the press, even before he had had a chance to present them to the cabinet, and in the belief that his remarks were off the record, declared that he was for acceptance. He then dug himself in deeper by telling the gathered reporters that any deal would have to satisfy Congress, many of whose representatives came from the West, where they "merely sell wheat and other products and take no further interest in the international debt or international trade." The headlines the next day announced that the British chancellor of the exchequer considered the average senator "a hick from way back."

The prime minister was furious. Having lost two of his sons in the war, Bonar Law had been all along deeply offended by the American view of war debts as just another commercial transaction. "I should be the most cursed Prime Minister that ever held office in England if I accepted those terms," he told Baldwin. On January 30, Baldwin made a strong plea in the cabinet for accepting the deal. He admitted that the Americans could have been more generous, that they had made great fortunes out of the war, that they worshipped the "G.o.d Almighty Dollar" but this was best that Britain was going to get.

Bonar Law spoke for rejecting the American offer. He had consulted Maynard Keynes, who counseled him to hold out, arguing that Britain should refuse the American offer "in order to give them [the Americans] time to discover that they are just as completely at our mercy as we are at France's and France at Germany's. It is the debtor who has the last word in these cases."

But Bonar Law was cornered-to disavow his chancellor who had so publicly endorsed the deal would create a crisis in the government. Outvoted in the cabinet, he accepted defeat, but did take the opportunity to let off steam in the traditional British manner-by writing an anonymous letter to the correspondence columns of the Times Times in which he vigorously attacked his own government's decision to accede to the American terms. in which he vigorously attacked his own government's decision to accede to the American terms.

Watching Britain strike such a poor bargain for itself, France chose to wait it out. It would eventually settle its war debts in 1926, when it reluctantly conceded to pay 40 cents on the dollar-even then the arrangement was not ratified by the National a.s.sembly until 1929. Italy did even better. When it settled, also in 1926, it would only agree to pay 24 cents on the dollar. As usual Keynes had been right-holding out would have given Britain a better deal.

As the decade went on, and the Americans insisted on extracting these payments, they were shocked to discover how intensely disliked they were in Europe. Journalists sent home articles dissecting the various sources of American unpopularity under such t.i.tles as "Europe Scowls at Rich America" or "Does Europe Hate the U.S. and Why?" or even "Uncle Shylock in Europe." One informal poll revealed that 60 percent of the French regarded the United States as their least favorite nation. The New York Times New York Times correspondent in Paris reported that "ninety out of a hundred regard Uncle Sam as selfish, as heartless, as grasping." Visiting Britain, the veteran American foreign correspondent Frank Simonds discovered that "the great majority of the British people have made up their minds that American policy is selfish, sordid and contemptible." correspondent in Paris reported that "ninety out of a hundred regard Uncle Sam as selfish, as heartless, as grasping." Visiting Britain, the veteran American foreign correspondent Frank Simonds discovered that "the great majority of the British people have made up their minds that American policy is selfish, sordid and contemptible."

But the really pernicious effect of war debts was that they made it hard, if not impossible, for Britain to forgo collecting its own debts from France and Germany, made France all the more obstinate in its efforts to collect reparations from Germany, and led Europe into a self-defeating vicious cycle of financial claims and counterclaims.

IN December 1922, as Norman set out for Washington, the Times Times of London profiled him: "Mr. Montagu Collet Norman, D.S.O., the Governor of the Bank of England . . . certainly one of the most interesting, as well as one of the most able men who have occupied the Chair for a generation or more." of London profiled him: "Mr. Montagu Collet Norman, D.S.O., the Governor of the Bank of England . . . certainly one of the most interesting, as well as one of the most able men who have occupied the Chair for a generation or more."

"In appearance he recalls the early Victorian statesmen," it went on, "Aristocratic in manner and temperament . . . his Shakespearian type of head sets well upon his tall, silent and dignified figure. A lover of music, poetry and books, Mr. Norman also possesses a collection of rare and beautiful woods. Many of those who come into contact with him feel that there is an indefinable touch of mystery about him. He has the keen sensitiveness of an 'intellectual.' "

It was remarkable how enormous was the change that had come over Norman since August 1914. Then he had been a pathetic figure, unsure of himself and uncertain about his future, wracked by neuroses, his less than ill.u.s.trious career cut short by mental illness. Now he was generally recognized as the most prominent and powerful banker in all Europe, if not the world.

From the very start of his tenure at the Bank, Norman had made a point of breaking the mold. Whereas his predecessors had been driven to work, resplendent in top hat and frock coat, he turned up in a business suit by way of the Underground-the Central Line from Notting Hill-with the ticket jauntily protruding from his hatband. His whole persona seemed to have been transformed. Almost everyone remarked on his graciousness, his courtly old-world manners, and most of all, the charm with which he was "singularly gifted." As one of his fellow directors put it, "He never made jokes or anything of that kind. He was just amusing. A continual bubble of wit."

In those five years, he had also acquired something of a mystique in the public mind. Before Norman, the governor of the Bank had generally been a figure of relative obscurity, known to only a few insiders within the Square Mile. But Norman's personality seemed to exert a powerful fascination on the press, which lauded him as a financial genius of great originality. All those traits, once viewed as the harmless eccentricities of a "strange old man"-his flamboyant way of dressing, his slouch hats, his artistic interests, his knowledge of Eastern philosophy-were now invested with great significance as signs of unusual creativity. His unorthodox appearance, his air of aloof amused amiability, perhaps above all his apparent lack of interest in money, for all his place at the very center of its mysteries, all contributed to the image of austere power, half patrician, half priestly.

This aura was reinforced by his policy of avoiding public appearances. He was rarely seen at the social events of the City, never made any speeches apart from the annual Mansion House toast required by tradition of the governor, and never submitted to newspaper interviews on the record.

It was during those early years that Norman got into the habit of traveling under pseudonyms, which became so much a part of his myth and mystique. It was the high point in the era of the transatlantic liner. The Times Times of London and the of London and the New York Times New York Times regularly ran features listing the most notable pa.s.sengers on the ocean liners scheduled to leave each week-generally extensions of the social pages heavily populated by amba.s.sadors, film stars, and European n.o.bility. regularly ran features listing the most notable pa.s.sengers on the ocean liners scheduled to leave each week-generally extensions of the social pages heavily populated by amba.s.sadors, film stars, and European n.o.bility.

News that the governor of the Bank of England was traveling to the United States inevitably gave rise to rumors: a settlement of war debts was imminent! Or Britain might return to the gold standard that week! To avoid all this unfounded speculation, Norman's secretary, Edward Skinner, began booking Norman's pa.s.sage under his own surname.

At some point in Norman's travels across the Atlantic, plain old Skinner became Professor Clarence Skinner. The story goes-one among many-that during one such trip, a Professor Clarence Skinner, professor of applied christianity at Tufts College in Medford, Ma.s.sachusetts, and a well-known Universalist who had actively campaigned to repeal the statutes prohibiting blasphemy, happened to be traveling on the same liner. The reporters, hovering at the West Side piers of Manhattan for a dockside interview, mistook Norman, with his professorial demeanor, for Professor Clarence Skinner. Norman did nothing to disabuse them of their misconception. Nor did the real professor, who, it seems, was quite amused. The whole incident so appealed to Norman's characteristically quirky sense of the absurd that, thereafter, he always traveled under the pseudonym, Professor Clarence Skinner. Over time, his alias was unmasked by the press. Nevertheless, he continued the practice, and talk of Professor Skinner and his travels became something of an in-joke among the cognoscenti.

Norman's dislike of any sort of press coverage and his attempts to conceal his activities from reporters only further fed their curiosity. Even the most ordinary incidents of his daily life were magnified and nourished speculation. The results could be comic and at times absurd.

Take a typical incident in March 1923, only days after France had occupied the Ruhr: Norman had left for his annual month's vacation in the south of France, where he generally stayed either with his half uncle at Costabelle, near Hyeres, or at the Hermitage Hotel in Nice. On this occasion, he decided to stop off in Paris for a few days of meetings with his counterparts at the Banque de France. Making no attempt to keep his trip a secret, he stayed at the prominent and well-known Hotel Crillon, on the Place de La Concorde. Nevertheless, because the Crillon had mistakenly registered him under the name Norman Montagu, the papers claimed that he was attempting to visit Paris incognito. When his valet was seen buying train tickets from a source other than the hotel's bureau, and was rumored to have been overheard asking the concierge about trains to Berlin, a wire report speculated that Norman was preparing to travel to Germany, and furthermore was attempting single-handedly to negotiate a settlement to the problem of reparations. The story ran in half the London press, and was picked up by many American papers, including the New York Times, New York Times, the the Washington Post, Washington Post, and the and the Chicago Tribune Chicago Tribune. In fact, after a few days in Paris, he left for Nice as usual.

Winston Churchill, who would come to know Norman all too well for his liking over the next few years, would later portray him in the Sunday Pictorial Sunday Pictorial: "Mr. Norman's dislike of publicity in any form has enshrouded him with an air of mystery, which has led to ordinary and casual incidents of his daily life being scrutinized and magnified by the money markets of the world. . . . The more he seeks privacy, the more significant his acts become. He travels under an a.s.sumed name, and is instantly identified. He remains in seclusion in his country home, and the United States is searched to make sure that he is not there. Indeed the very process of self-effacement has proved-to his added disgust-the most subtle and effective form of advertis.e.m.e.nt. . . . It may well be that a little more plain speech . . . would have served his real purpose better than so much silence and precaution."

Not everyone was taken by his charm or his personality. Hating arguments or direct confrontations, he got his way by going around opponents and consequently developed a reputation for subterfuge. Some people retained a suspicion that Norman's attempts to cloak himself in mystery were simply a more subtle and sophisticated form of showmanship. Lord Vansitartt, head of the British diplomatic service between the wars, dismissed him as a "poseur."

And while Norman's public persona may have changed dramatically, he still carried within him many of the same private demons that had beset him before the war. He was by nature a pessimist, p.r.o.ne to bouts of despair, unfortunate traits in a central banker confronted with the task of nursing a crippled economy back to health. During that first grim year in office, as he struggled with a weak pound and the depths of a recession, he wrote of his "sensation of being as it were tossed about on a sea in which I can hardly swim."

Francis Williams, then city editor of the left-wing Daily Herald Daily Herald, considered that though Norman was able to exert a strange fascination over the City, he was "secretive, egotistic, suspicious of intellectual ability, and almost incapable of normal human relationships." Lord Cunliffe may have got the best measure of him when he confided that he thought Norman, "a brilliant neurotic personality [who] is certain to cause trouble. . . ." He added, "He's not an ordinary personality. . . . He needs the power just to keep going and he won't give it up until it's too late."

DURING THE EARLY 1920s, Norman would often talk of creating a league of central bankers to take responsibility for stabilizing European finances and promoting world economic recovery. No government seemed capable of doing it and he thought-a little grandiosely-that his guild could somehow fill the vacuum left by politicians. He liked to envisage himself and the other members of his small brotherhood as elite tribunes, standing above the fray of politics, national resentments, and amateur nostrums. Though Norman "delighted in appearing unconventional," his views about society were very much "those of an old Etonian." Still an Edwardian, he clung to the belief in aristocratic government.

In March 1922, he wrote to Strong in that elliptical way of his, "Only lately have the countries of the world started to clear up after the war, two years having been wasted in building castles in the air and pulling them down again. Such is the way of democracies it seems, though a 'few aristocrats' in all countries realized from the start what must be the inevitable result of hastily conceived remedies for such serious ills." He obviously thought that the "few aristocrats" were bankers like himself.

At this stage, though, he was the one building castles in the air. His notion that the world's central bankers would not be subject to the same nationalistic pressures to which politicians were also responding was curiously naive. His vision of a league of the lords of world finance was at this stage largely a pipe dream. He could not even get Strong to support him fully. After the Genoa Economic Conference of 1922, he floated the idea of a grand conclave of central bankers. But Strong resisted the idea, fearing that the United States, as the world's major creditor, would be ambushed by a concert of its European debtors, all clamoring for America with its vast gold reserves to refloat them. As he wrote to Norman, "Anything in the nature of a league or alliance, with world conditions as they are, is necessarily filled with peril." It would, he feared, be like "handing a blank check to some of the impoverished nations of the world, or to their banks of issue, and especially to those whose finances are in complete disorder and quite beyond control."

By 1923, Norman's club consisted essentially of himself and Strong, commiserating with each other over their respective health problems and the economic anarchy that seemed to surround them. Their friendship, however, had blossomed.

After Norman's three trips to the United States in 1921 and 1922, they did not see each other again for almost eighteen months. Falling ill once more, Strong had to take a leave of absence for most of 1923. Thereafter, they agreed to meet at least twice a year, alternating generally between Europe in the summer and New York in the winter. They wrote to each other every few weeks-a combination of financial gossip and views about economic policy. Despite their closeness, they usually addressed each other, in the quaintly formal style of the day, as "Dear Strong" or "Dear Norman," although letting their hair down on occasion with "Dear Strongy," "Dear Old Man," or "Dear old [sic] Monty." They furnished each other with advice, often revealing confidential details to which even their own colleagues were not privy. Occasionally they scolded each other. When Norman operated too much on his own and failed to consult his own directors, Strong admonished him, "You are a dear queer old duck and one of my duties seems to be to lecture you now and then."

It was not all about work. They often ribbed each other affectionately. On one occasion, Norman, who had just returned from a visit to Strong in New York and discovered that he had packed one of Strong's jackets by mistake, wrote: Dear Ben,Since I wrote on the steamer, a further crime has been discovered. The second evening I was home, as usual I changed clothes in the evening and on going downstairs discovered myself in the disguise of a gentleman, if not a dude! This was due to velvet jacket of good style, fit and finish: In other words, Ben, I can only look respectable with the help of your wardrobe!

At times, they sounded like a couple of harmless old bachelors who took great pleasure in joshing each other-whether over an oil portrait of Strong upon which Norman had stumbled in the pages of Town and Country Town and Country , or Norman's irritability when Thorpe Lodge was under repair, or his engagement with the philosophy of Spinoza. , or Norman's irritability when Thorpe Lodge was under repair, or his engagement with the philosophy of Spinoza.

Norman, by nature the more emotional, could be gushing and sentimental and fussed over his friend's health. "Let me beg you to care for yourself more than you seem to be doing. You belong to others quite as much as to yourself," he wrote after a 1921 visit to New York. He lectured Strong about smoking too many Camels and insisted on details about "what is happening to your pulse & sleep & pins & breathing . . . not a word have I heard for 4 weeks." The more aloof Strong, with a large family of his own, had less need to confide. But each was the other's closest friend. In 1927 after a visit from Norman while he was down with pneumonia, Strong too would write, "To have a sympathetic person to talk over matters is helpful anyway, but when it is a best friend, it is more than that."

By 1923, they were seriously fearing for the future. The first few years of peace, begun so hopefully, had turned out to be a time of great frustration and disappointment for both. The United States had washed its hands of European affairs and retreated into isolation. Currencies in Europe remained unstable. Neither of them could do much about the failures of economic policy in Germany or France, both paralyzed by reparations: Germany refusing to do anything to stabilize its economy until a fairer settlement was established, France in its turn insisting that it could make no concessions until a deal was reached on its war debts to Britain and America.

Norman saw "the Civilization of Europe" at stake. But all he could do was watch gloomily from the sidelines as matters continued to deteriorate. He became increasingly pro-German and anti-French. French obstinacy during the reparations dispute only served to reinforce his private prejudices, particularly against the French political cla.s.s, which in his view was uniformly venal, underhanded, corrupt, and dishonorable. "The black spot of Europe and the world continues to be on the Rhine," he wrote to Strong after the occupation of the Ruhr. "There you have all the conditions of war except that one side is unarmed. How long can Germany continue thus?"

For Strong the frustrations were more personal. Though he remained financially comfortable, over the years he had to adjust his lifestyle drastically. The contrast between his relatively modest way of living and those of his old colleagues in the private sector could not have been more apparent. Following his separation and divorce, he lived in a series of small apartments, initially in a suite at the Plaza Hotel, and from mid-1922, in a small two-bedroom apartment in midtown Manhattan. Harry Davison had the benefit of a mansion on Park Avenue, a sixty-acre estate on the North Sh.o.r.e of Long Island, and a plantation estate in Georgia, until he died suddenly of a brain tumor in May 1922. Meanwhile Thomas Lamont, the embodiment to Strong of the road not taken, lived in a large town house at Seventieth Street and Park Avenue, continued to use his property in Englewood during the spring, and summered on his estate in North Haven, Maine.

Strong continued to be plagued by illness. In February 1923, the tuberculosis spread to his larynx, forcing him to take yet another extended leave of absence in Colorado-his fourth in seven years-from which he returned to work in October, and then only part time. Since he had first contracted the disease in 1916, he had spent almost half the time away from his desk. Even when he was nominally at work, he was often incapacitated, "afflicted by the generous use of morphine," to control the terrible pain. He had aged enormously. Compelled to give up tennis and other vigorous exercise, he had put on weight and was losing his hair. He looked haggard and overworked, almost unrecognizable from the tall, slim, confident, good-looking young man of ten years earlier.

In those days, even after his first wife's death, he had always been very social and clubby. Now he rarely went out at night and was never seen at the theater or the opera. His job was his anodyne, his evenings devoted to quiet working dinners with other bankers and officials.

In early 1924, with both his sons talking of getting married, he wrote to Norman: "The temptation is constantly before me to wind up my work and quit, do some traveling, a little writing, and take things easy." Neither of them foresaw that after four years of frustration they were on the verge of achieving their goals.

Maynard Keynes's Wedding, 1925

9. A BARBAROUS RELIC.

THE GOLD Standard Time will run back and fetch the age of gold.

-JOHN MILTON, On the Morning of Christ's Nativity

AFTER THE WAR, there was a universal consensus among bankers that the world must return to the gold standard as quickly as possible. The almost theological belief in gold as the foundation for money was so embedded in their thinking, so much a part of their mental equipment for framing the world, that few could see any other way to organize the international monetary system. Leading that quest were Montagu Norman and Benjamin Strong.

The biggest obstacle to such a return was the mountain of paper currency issued by the central banks of the belligerent powers during the war. Take Britain, for example. In 1913, the total amount of money circulating in the country-gold and silver coins; notes issued by the Bank of England and by the large commercial banks; and the largest category, bank deposits-amounted to the equivalent of $5 billion. This supply of money, in all its various forms, was backed in aggregate by the country's $800 million of gold, surprisingly only $150 million of which was held in the vaults of the Bank of England, the remainder consisting of gold coins in circulation or bullion held by the commercial banks, such as Barclays or Midland. By 1920, the Bank of England had lent so much money to the government to help pay for the war effort that the total money supply had ballooned to the equivalent of $12 billion, which in turn had driven prices up by two and a half times. Britain's gold reserves meanwhile remained roughly the same. Thus, whereas in 1913, there had been 15 cents worth of gold within the country for every $1 dollar in money, in 1920 each $1 of money was backed by less than 7 cents. The Bank of England made every effort to economize on gold, for example, by replacing gold coins with paper currency, and by concentrating the bullion originally held by commercial banks into its own holdings. Nevertheless, at war's end it was clear that the country's reserves would not provide enough of a monetary cushion for Britain to contemplate returning to gold at the old 1914 exchange rate.

Every nation involved in the war, even the United States, faced the same dilemma. For all had resorted to inflationary finance to a greater or lesser degree. There were essentially only two ways to restore the past balance between the value of gold reserves and the total money supply. One was to put the whole process of inflation into reverse and deflate the monetary bubble by actually contracting the amount of currency in circulation. This was the path of redemption. But it was painful. For it inescapably involved a period of dramatically tight credit and high interest rates, a move that was almost bound to lead to recession and unemployment, at least until prices were forced down.

The alternative was to accept that past mistakes were now irreversible, and reestablish monetary balance with a sweep of the pen by reducing the value of the domestic currency in terms of gold-in other words, formally devalue the currency. This sounds painless. But to a generation reared on the certainties of the gold standard, devaluation was viewed as a disguised form of expropriation, a way of cheating investors and creditors out of the true value of their savings-which to some degree it was. Moreover, it was not completely costless. Central banks that resorted to devaluation as a way of cleaning up a past monetary mess were viewed as the financial equivalent of reformed alcoholics-it was hard to clear the stain on their reputations for financial discipline, and as a consequence, they generally had to pay up to borrow.

A simple a.n.a.logy of the choice between deflation and devaluation might be that of the man who has put on weight and is having a hard time fitting into his clothes. He can either choose to lose the weight-that is, deflate-or alternatively accept that his larger waistline is now irreversible and have his clothes altered-that is, devalue. Whether to deflate or devalue became the central economic decision for every country after the war. The burden of deflation fell on workers, businesses, and borrowers, that of devaluation on savers. The fate of the world economy would hinge over the next two decades on which path each country took. The United States and Britain took the route of deflation, Germany and France that of devaluation.

Of all the belligerents, the United States, having come late to the war and having spent the least of any of the major powers, was in the best financial shape. Though it, too, had allowed its currency to expand by 250 percent during the war, and prices to double, it also had seen its gold reserves more than double as the enormous European purchases of war materials and the ma.s.sive flight of European capital seeking safety across the Atlantic, carried over $2 billion worth of gold into the United States. By 1920, the country held close to $4 billion in gold. Even allowing for war inflation, therefore, it still had a comfortable reserve of bullion to back its expanded currency base, and was able to return to the gold standard almost immediately after hostilities ceased.

Even in the United States, the return to gold and monetary stability was not completely painless. In 1919 and 1920, after the years of wartime austerity, consumers let rip and went on a buying binge; inflation began to accelerate and for a brief moment, seemed about to spin out of control. Strong reacted forcefully, leading a move by the Fed to tighten credit policy dramatically by raising interest rates to 7 percent and keeping them there for a full year. This constriction was accompanied by a similar move by the federal government to bring its budget into balance. The economy plunged into recession. Over two and a half million men lost their jobs. Bankruptcies soared. But by the end of 1921, with prices down by almost a third, the economy once again began to recover. During the next seven years, the U.S. economy, led by new technologies such as automobiles and communications, would experience an unprecedented period of strong growth and low inflation.

At the opposite end of the spectrum from the United States was Germany, which had taken the path of least resistance during the war and expanded its money supply by 400 percent. By the end of 1920, German prices stood at ten times their 1913 level. Germany had issued so much currency that it had no hope of being able to reverse the process, and when the war ended, seemed clearly headed for a ma.s.sive devaluation. In retrospect, that would have been a blessing. But instead of trying to rebuild its finances, the German government adopted a policy of systematic inflation, in part to meet reparations, and thus launched itself on that voyage of fantasy into the outer realms of the monetary universe.

FIGURE 1.

Britain and France lay somewhere in between. During the war, France had expanded its currency by 350 percent, pushing up prices equivalently. After the war, the Banque de France avoided German-style hyperinflation and currency collapse by putting a lid on the issue of new currency. However, France continued to flirt with disaster by running budget deficits of $500 million and was saved once again only by the remarkable thriftiness of its people. While there was a group within the Banque who harbored the fantasy of reversing the more than threefold price increase and returning the franc to gold at its prewar parity, most rational observers agreed that when France returned to the gold standard, it would have to be at a radically lower exchange rate-and even that still seemed many years away.

Britain was therefore the only major country that truly faced the choice between devaluation and deflation. To a modern observer, less wedded to the principle that currency rates are sacrosanct, some measure of devaluation would have made sense. After all, Britain was finding it harder to compete in the postwar world economy and, having liquidated vast amounts of its holdings abroad, could only draw upon a much reduced foreign income to cushion the blow. Its exchange rate should have been allowed to fall as a means of making its goods cheaper on world markets.

However, Norman and his generation lived in a different mental world. They saw devaluation not as an adjustment to a new reality but as something more, a symptom of financial indiscipline that might precipitate a collective loss of confidence in all currencies. When people talked of the City of London as banker to the world, this was no mere figure of speech-the City operated literally like a gigantic bank, taking deposits from one part of the world and lending to another. While gold was the international currency par excellence, the pound sterling was viewed as its closest subst.i.tute, and most trading nations-the United States, Russia, j.a.pan, India, Argentina-even kept part of their cash reserves in sterling deposits in London. The pound had a special status in the gold standard constellation and its devaluation would have rocked the financial world.

In the last months of the war, the British government set up a commission, chaired by the ubiquitous Lord Cunliffe, only recently departed from the Bank of England, and including Sir John Bradbury of the UK Treasury; A. C. Pigou, professor of political economy at Cambridge; and ten bankers from the City, to review postwar currency arrangements. Twenty-three parties gave evidence before the commission, every one of them, with not single note of dissent, in favor of a return to gold at the prewar rate. To a man, they believed the restoration of the traditional parity was essential if Britain was to retain its position at the hub of the world's banking system.

The model they had in mind, which was especially seared into the collective memory of the Bank of England, was Britain's experience a century earlier after the Napoleonic Wars. In 1797, four years into the Revolutionary war with France, there was a run on the Bank of England, provoked by rumors that a French army had landed in Wales. The Bank, which had begun the war with gold reserves of 9 million, saw them shrink to 1 million, and was forced, as it would be in 1914, to abandon the gold standard. Under the pressures of war finance, Bank of England notes, which formed the basis for paper money in the country, increased over the next fifteen years from 10 million to over 22 million, doubling prices.

In 1810, a parliamentary inquiry known as the Bullion Committee was formed to examine the whole issue. The committee included Henry Thornton, a banker, parliamentarian, brother to a director of the Bank of England, and the most creative monetary economist of the nineteenth century, whose insights would unfortunately be lost by succeeding generations in charge at the Bank. The committee recommended that the Bank resume gold payments as soon as possible, and in order to achieve this goal, begin to contract its credits to banks and merchants and shrink the supply of paper money by withdrawing its notes from circulation. The Bank wisely waited until 1815, when a defeated Napoleon was safely in exile on St. Helena, before taking this advice. Over the next six years, it almost halved the supply of paper money in Britain, driving down prices by 50 percent. And though those years from 1815 to 1821 had been years of riots and agricultural distress, Britain went back on gold in 1821. Over the subsequent half century, it transformed itself into the world's largest economic power. Many believed that the "resumption" of 1821 had been the single most important defining decision in its financial history. That the Bank had been willing to inflict the pain of a 50 percent fall in prices in order to restore the gold value of the pound had set sterling apart from every other currency in Europe, and made it the world's premier store of value.

Inspired by this example-and in complete contrast to every other European country-in 1920, the Bank of England chose the path of deflation, matching the Fed and raising interest rates to 7 percent. The budget was balanced. The economy plunged into sharp recession, two million men were thrown out of work. Nevertheless, by the end of 1922, the Bank had succeeded in bringing prices down by 50 percent, and the pound, which had fallen as low as $3.20 in the foreign exchange market on the fear that Britain was headed for devaluation, climbed back to within 10 percent of its prewar parity of $4.86.

But whereas the U.S. economy, more dynamic and unhampered by a large internal debt, was quickly able to bounce back from the recession, Britain remained stuck. The number of unemployed would not fall below one million for the next twenty years. It soon became apparent that Britain had sustained terrible damage as an economic power during the war. Industries such as cotton, coal, and shipbuilding, in which it had once led the world, had failed to modernize and the traditional markets had been lost to compet.i.tors. Labor costs had risen as unions negotiated shorter working hours.

Norman now faced the uneasy prospect that the only way to follow the example set by his forerunners-his grandfather joined the Court the year of "resumption"-was by keeping unemployment high. But while before the war it might have been politically acceptable to create unemployment deliberately in order to support the currency, in the charged climate after the war-with Lloyd George promising the electorate "a land fit for heroes"-Norman would find himself constantly under pressure to find an alternative.

THE problem of resurrecting the gold standard went much deeper than selecting new exchange rates for the key currencies, for the war had brought about such a tectonic shift in the distribution of gold reserves that it seemed to threaten the very viability of a monetary system resting on gold.

Before the war, the four largest economies-the United States, Britain, Germany, and France-had operated their monetary systems with about $5 billion worth of gold among them. The amount of new gold mined during the war was small, and by 1923, monetary gold had increased only to $6 billion. Meanwhile, prices in the United States and the UK, even after the postwar deflation, were still 50 percent higher than before the war, which meant that in effect the real purchasing power of gold reserves had contracted by almost 25 percent.

FIGURE 2.

In 1922, Norman worked with officials at the British Treasury to develop a plan whereby some of the European central banks would, as did many countries in the British Empire, hold pounds rather than gold as their reserve a.s.set-in much the same way that many central banks hold dollars nowadays. He argued that subst.i.tuting pounds for gold would allow the world to economize on the precious metal and thus reduce the risk of worldwide shortage. Few people failed to notice that by creating a captive source of demand for sterling, the plan would add to its privileged position in the constellation of currencies and greatly ease his job of returning the pound to gold. The plan never really did take off, except in a few minor Central European countries.

The bigger concern among bankers after the war was not so much that the world was short of gold, but that too much of the gold was concentrated in the United States. Before the war, there had been some parity among the major economic powers between the amount of gold in each banking system and the size of its economy. For example, the United States, with a GDP of $40 billion, accounted for about half the output of the four great economic powers and held about $2 billion in gold, a little less than half of the total gold of these four countries. The balance was only rough and ready-France held proportionately more and Britain less-but the system worked with remarkable smoothness.

By 1923, the United States had acc.u.mulated close to $4.5 billion of the $6 billion in gold reserves of the four major economic powers, far in excess of what it needed to sustain its economy. About $400 million circulated in the form of coins; the remainder consisted of ingots, small bars the size of a quart of milk, each weighing about twenty-five pounds, stored in the vaults of the Federal Reserve Banks and the Treasury. The largest h.o.a.rd lay under lower Manhattan, about $1.5 billion in the Treasury repository at the legendary intersection of Broad and Wall Streets, and at the New York Fed. The remainder was scattered among the eleven other Federal Reserve Banks across the country.20 By one estimate, excess gold reserves in the United States amounted to about a third of its holdings, roughly $1.5 billion. By one estimate, excess gold reserves in the United States amounted to about a third of its holdings, roughly $1.5 billion.

While the U.S. monetary system was swamped by this enormous surplus, Europe, particularly Britain and Germany, suffered a chronic shortage. The three big European economies, which had operated before the war on $3 billion worth of gold, were left with barely half that. Faced with constant demands to pay out gold, European central banks had resorted to a complex of measures, the most important being to withdraw gold coins from circulation. All those solid talismans of turn-of-the-century middle-cla.s.s prosperity had gradually disappeared from Europe's pockets, to be replaced by shabby pieces of paper. By the mid-1920s, the United States was the only large country where one could still find gold coins.

The concentration of the world's key precious metal in the United States had left the rest of the world with insufficient reserves to grease the machinery of trade. The world of the international gold standard had become like a poker table at which one player has acc.u.mulated all the chips, and the game simply cannot get back into play.

ONE MAN WHO had no difficulty liberating himself from the strictures of the gold standard was John Maynard Keynes. After the Peace Conference, he had gone back to teaching at Cambridge. But following the resounding success of The Economic Consequences of the Peace, The Economic Consequences of the Peace, he reduced his involvement with the university and became increasingly caught up on the grander stage of world affairs. He joined the board of an insurance company and became chairman of the weekly British magazine the he reduced his involvement with the university and became increasingly caught up on the grander stage of world affairs. He joined the board of an insurance company and became chairman of the weekly British magazine the Nation, Nation, for which he wrote regular pieces, as he did for the for which he wrote regular pieces, as he did for the Manchester Guardian Manchester Guardian, articles that were syndicated around the world, including in the U.S. weekly the New Republic New Republic. And he began making his fortune as a currency speculator.

In 1919, it was a novel way of making money. Before 1914, currencies had been fixed, and opportunities to profit from the instability of exchange rates had been almost nonexistent. In the aftermath of the war, as exchange rates of the major currencies lurched up and down, it became possible to make large returns-and also lose equally large amounts-by betting on the direction of such moves. In the latter half of 1919, convinced that the inflationary consequences of the war would undermine the currencies of the main belligerents, Keynes went short on the French franc, the German Reichsmark, and the Italian lira, buying the currencies of countries that had sat out most of the war: the Norwegian and the Danish kroner, the U.S. dollar, and interestingly enough, the Indian rupee. He made $30,000 in the first few months. In early 1920, he set up a syndicate, with his brother, some of the Bloomsbury circle, and a financier friend from the City of London. By the end of April 1920, they had made a further $80,000. Then suddenly, in the s.p.a.ce of four weeks, a spasm of optimism about Germany briefly drove the declining European currencies back up, wiping out their entire capital. Keynes found himself on the verge of bankruptcy and had to be bailed out by his tolerant father. Nevertheless, propped up by his indulgent family and by a loan from the coolly acute financier Sir Ernest Ca.s.sel, he persevered in his speculations-built for the most part around the view that the German and Central European currencies were headed for disaster. By the end of 1922, he had ama.s.sed a modest nest egg of close to $120,000.

But by far the most important development in his life was that he had fallen in love-this time with a woman, Lydia Lopokova, a married Russian emigree ballerina, no less. The daughter of a Russian father, an usher at the Imperial Alexandrinsky Theater, and a Scottish-German mother, Lydia came from a family of dancers-her two brothers and a sister had also gone to the Imperial Ballet School in St. Petersburg. When Maynard met her in 1918, she was traveling with the Diaghilev Ballet, having spent seven years in the United States as a cabaret artist, model, and vaudeville performer, and was married to the business manager of the company, Randolfo Barrochi. After her marriage broke down, she disappeared into Russia, then in the thick of civil war, with a mysterious White Russian general, but reappeared in Keynes's life at the end of 1921.

Though they would not get married until 1925 when her divorce finally came through, they began living together in 1923. They made an unlikely couple-he a brilliant and all too cerebral intellectual with a genius for exposition, she an unpredictable artist with a risque past, a flighty and vivacious chatterbox with an equal skill for stumbling into the most memorable malapropisms. She once complained that she "disliked being in the country in August, because my legs get so bitten by barristers." On another occasion, after visiting an aviary, she remarked on her hostess's "ovary." And though the rest of Bloomsbury looked down on her, Keynes was to remain completely enchanted with her for the rest of his life.

In December 1923, Keynes published a short monograph, A Tract on Monetary Reform, A Tract on Monetary Reform, much of which had already appeared as a series of articles in the much of which had already appeared as a series of articles in the Manchester Guardian Manchester Guardian during 1922 and early 1923-his first systematic attempt to unravel the sources and consequences of the chronic monetary instability that plagued the postwar world. Like his earlier book, during 1922 and early 1923-his first systematic attempt to unravel the sources and consequences of the chronic monetary instability that plagued the postwar world. Like his earlier book, A Tract A Tract was a strange hybrid, this time a half-theoretical treatise-with sections on "The Theory of Purchasing Power Parity" and "The Forward Market in Exchanges" and half pamphlet for the laity. It was, however, very different in tone from was a strange hybrid, this time a half-theoretical treatise-with sections on "The Theory of Purchasing Power Parity" and "The Forward Market in Exchanges" and half pamphlet for the laity. It was, however, very different in tone from The Economic Consequences. The Economic Consequences. That had been an angry, pa.s.sionate work, written in the heat of debate and controversy. This one had a lighter touch, a "tentative almost diffident tone," as if the author himself were searching for the answer to the quest for monetary stability. That had been an angry, pa.s.sionate work, written in the heat of debate and controversy. This one had a lighter touch, a "tentative almost diffident tone," as if the author himself were searching for the answer to the quest for monetary stability.

Before the war, however much he had enjoyed challenging conventional nostrums about morality, conduct, and society, in economics Keynes had fully embraced the liberal orthodoxy that dominated his still nascent profession. He believed in free trade, in the unfettered mobility of capital, and in the virtues of the gold standard.

There were times when, like so many other economists, he might speculate whether gold was the right foundation for money. But those had been largely theoretical ruminations; and ultimately, when it came down to it, there seemed no other practical basis so tried and tested upon which to organize the world's currencies. Asked at the height of the 1914 crisis to brief the chancellor of the exchequer as to whether the pound should remain tied to gold, he had come down very strongly in favor of maintaining the link: "London's position as a monetary center depends very directly very directly on complete confidence in London's unwavering readiness" to meet its obligations in gold and would be severely damaged if "at the on complete confidence in London's unwavering readiness" to meet its obligations in gold and would be severely damaged if "at the first first sign of emergency" that commitment was suspended. sign of emergency" that commitment was suspended.

Even during the first years after the war, he was still advocating a return to gold. But the shift in the world's economic landscape was beginning to give him doubts. He still believed that the prime goal of central bank policy should be to keep prices broadly stable. But whereas before the war he had thought that the best way to achieve this was to ensure that currencies such as the pound be fully convertible to gold at a fixed value, he had now come to believe that there was no reason why linking money supply and credit to gold should necessarily result in stable prices.

The gold standard had only worked in the late nineteenth century because new mining discoveries had fortuitously kept pace with economic growth. There was no guarantee that this accident of history would continue. Moreover, while the original rationale for a gold standard-the commitment that paper money could be converted into something unequivocally tangible-might have been necessary to instill confidence at some point in history, this was no longer the case. Att.i.tudes toward paper money had evolved and it was not necessary to allow the supply of precious metals to regulate the creation of credit in a sophisticated modern economy. Central banks were perfectly capable of managing their countries' monetary affairs rationally and responsibly, he argued, without any need to shackle themselves to this "barbarous relic."