Lords of Finance_ The Bankers Who Broke the World Part 6

Though the Tract Tract was a technical monograph, the Cambridge undergraduate in Keynes could not resist lacing the book with the playful sarcasms that had made was a technical monograph, the Cambridge undergraduate in Keynes could not resist lacing the book with the playful sarcasms that had made The Economic Consequences The Economic Consequences such a success. He flippantly dedicated the book, "humbly and without permission, to the Governors and the Court of the Bank of England," knowing very well that the members of that august body would disagree with almost everything he had to say. He poked fun at the self-importance of those "conservative bankers" who "regard it as more consonant with their cloth, and also as economizing on thought, to shift public discussion of financial topics off the logical on to an alleged moral plane, which means a realm of thought where vested interest can be triumphant over the common good without further debate." And he peppered it with the sort of bons mots-the most famous being "in the long run we are all dead"-that made him so scintillating a conversationalist. such a success. He flippantly dedicated the book, "humbly and without permission, to the Governors and the Court of the Bank of England," knowing very well that the members of that august body would disagree with almost everything he had to say. He poked fun at the self-importance of those "conservative bankers" who "regard it as more consonant with their cloth, and also as economizing on thought, to shift public discussion of financial topics off the logical on to an alleged moral plane, which means a realm of thought where vested interest can be triumphant over the common good without further debate." And he peppered it with the sort of bons mots-the most famous being "in the long run we are all dead"-that made him so scintillating a conversationalist.

But more than anything else it was Keynes's ability to strip away the surface of monetary phenomena and reveal some of its deeper realities and its connections to the society at large that has made the Tract Tract such an enduring cla.s.sic. For example, by tracing through the consequences of rising prices on different cla.s.ses in a stylized picture of the economy-what economists today might call a model-he showed that inflation was much more than simply prices going up, but also a subtle mechanism for transferring wealth between social groups-from savers, creditors, and wage earners to the government, debtors, and businessmen. He thus highlighted the fact that the postwar inflation in countries such as France and Germany was not just the result of an error in monetary policy. Rather, it was a symptom of the fundamental disagreement that had wracked European society since the war about how to share the acc.u.mulated financial burden of that terrible conflict. such an enduring cla.s.sic. For example, by tracing through the consequences of rising prices on different cla.s.ses in a stylized picture of the economy-what economists today might call a model-he showed that inflation was much more than simply prices going up, but also a subtle mechanism for transferring wealth between social groups-from savers, creditors, and wage earners to the government, debtors, and businessmen. He thus highlighted the fact that the postwar inflation in countries such as France and Germany was not just the result of an error in monetary policy. Rather, it was a symptom of the fundamental disagreement that had wracked European society since the war about how to share the acc.u.mulated financial burden of that terrible conflict.

In contrast to The Economic Consequences, The Economic Consequences, the new book had almost no practical impact. At a time when the currencies of Central Europe had completely collapsed and the franc was perilously close to the edge, few people could be convinced to entrust the management of national moneys and currency values to the discretion of treasury mandarins, politicians, or central bankers. There were too many examples to point to-Germany, Austria, Hungary, admittedly some of them pathologically extreme-of what could happen when the discipline of gold was removed. But the experience of the next decade would, in the words of one of Keynes's biographers, win for the the new book had almost no practical impact. At a time when the currencies of Central Europe had completely collapsed and the franc was perilously close to the edge, few people could be convinced to entrust the management of national moneys and currency values to the discretion of treasury mandarins, politicians, or central bankers. There were too many examples to point to-Germany, Austria, Hungary, admittedly some of them pathologically extreme-of what could happen when the discipline of gold was removed. But the experience of the next decade would, in the words of one of Keynes's biographers, win for the Tract Tract "the allegiance of half the world." "the allegiance of half the world."

NORMAN'S RESPONSE To the Tract Tract was predictably to dismiss it as the froth of a clever dilettante. As he wrote to Strong, "For the moment Mr. Keynes seems to have rather outdone himself, a fact that perhaps comes from his trying to combine the position of financial mentor to this and other countries with that of a high-cla.s.s speculator." was predictably to dismiss it as the froth of a clever dilettante. As he wrote to Strong, "For the moment Mr. Keynes seems to have rather outdone himself, a fact that perhaps comes from his trying to combine the position of financial mentor to this and other countries with that of a high-cla.s.s speculator."

What separated Norman from Keynes had less to do with economics and more to do with philosophy and worldview. For Norman, the gold standard was not simply a convenient mechanism for regulating the money supply, the efficiency of which was an empirical question. He thought about it in much more existential terms. It was one of the pillars of a free society, like property rights or habeas corpus, which had evolved in the Western liberal world to limit the power of government-in this case its power to debase money. Without such a discipline to protect them, central banks would inevitably come under constant pressure to help finance their governments in much the same way that they had done during the war with all the inflationary consequences that were still all too apparent. The link with gold was the only sure defense against such a downward spiral in the value of money.

His reaction to the Tract Tract was colored by his personal dealings with Keynes. After the war, Norman, agreeing with much of Keynes's argument on reparations, had consulted him at the height of the German hyperinflation. But Keynes's vocal opposition to the war-debt settlement with the United States, which Norman had been responsible for engineering, created a rift. Norman, acutely sensitive to public criticism, harbored grudges for a long time-"the most vindictive man I have ever known," according to one close friend. Thereafter, though their social circles overlapped somewhat and though Keynes, for all his youthful iconoclasm, was already widely recognized as the most brilliant monetary economist of his generation, Norman studiously ignored him professionally, and refused ever to invite him to advise the Bank. was colored by his personal dealings with Keynes. After the war, Norman, agreeing with much of Keynes's argument on reparations, had consulted him at the height of the German hyperinflation. But Keynes's vocal opposition to the war-debt settlement with the United States, which Norman had been responsible for engineering, created a rift. Norman, acutely sensitive to public criticism, harbored grudges for a long time-"the most vindictive man I have ever known," according to one close friend. Thereafter, though their social circles overlapped somewhat and though Keynes, for all his youthful iconoclasm, was already widely recognized as the most brilliant monetary economist of his generation, Norman studiously ignored him professionally, and refused ever to invite him to advise the Bank.

Strong's reactions were on the surface similar to Norman's. He had never met Keynes, but given his puritan background, he would have vehemently disapproved of the Bloomsbury irreverence and mockery of authority. When The Economic Consequences The Economic Consequences came out, he had written of Keynes, "He is a brilliant but, I fear, somewhat erratic chap, with great power for good and, unfortunately . . . some capacity for harm." Many in his circle had taken offense at Keynes's merciless lampooning of Woodrow Wilson at the Peace Conference. He echoed this again in his reaction to the came out, he had written of Keynes, "He is a brilliant but, I fear, somewhat erratic chap, with great power for good and, unfortunately . . . some capacity for harm." Many in his circle had taken offense at Keynes's merciless lampooning of Woodrow Wilson at the Peace Conference. He echoed this again in his reaction to the Tract Tract. "Keynes' little book arrived safely and I am just now reading it," he wrote to Norman on January 4, 1924, from the Arizona desert. "I have a great respect for his ability and the freshness and versatility of his mind, but I am much afraid of some of his more erratic ideas, which impressed me as being the product of a vivid imagination without very much practical experience."

The hidden irony was that every one of Keynes's main recommendations-that the link between gold balances and the creation of credit be severed, that the automatic mechanism of the gold standard be replaced with a system of managed money, that credit policy be geared toward domestic price stability-corresponded precisely to the policies Strong had inst.i.tuted in the United States.

During the war, the flow of gold into the United States had pushed up prices by 60 percent. When the fighting ended, but turmoil in Europe continued and the gold still kept arriving, Strong decided that it was time to abandon the conventional rules of the gold standard and insulate the U.S. economy from the flood of bullion. The system was being swamped by so much excess gold that to have followed the traditional dictates of the gold standard would have led to a ma.s.sive expansion of domestic credit, which inevitably would have led to very high rates of inflation-Strong calculated that it would cause prices to double. It made no sense to him for the United States to import, in effect, the inflationary policies of Europe and destabilize its own monetary system just because the Old World had been hit by political and financial disaster. The Fed therefore began to short-circuit the effects of additional gold on the money supply by contracting the amount of credit that it supplied to banks, thus offsetting any liquidity from gold inflows.

Having jettisoned the simple operating procedures of the gold standard, which linked credit creation solely to gold reserves, Strong began to improvise an alternative set of principles to guide monetary policy. The Fed's primary goal should be, he believed, to try to stabilize domestic prices. But he thought that it should also respond to fluctuations in business activity-in other words, the Fed should try to fine-tune the economy by opening the spigot of credit when commercial conditions were weakening and closing it as the economy strengthened.

This new set of principles, somewhat cobbled together on the fly, represented a quiet, indeed carefully unheralded, revolution in monetary policy. Until then central bankers had seen their primary task as protecting the currency and confined their responsibilities to ensuring that the gold standard was given free rein, only stepping in at times of crisis or panic. The credit policy of every industrial country had been driven by one factor alone: gold reserves. The United States was, however, now so flush with gold that the solidity of its currency was a.s.sured. Led by Strong, the Fed had undertaken a totally new responsibility-that of promoting internal economic stability.

It was Strong more than anyone else who invented the modern central banker. When we watch Ben Bernanke or, before him, Alan Greenspan or Jean-Claude Trichet or Mervyn King describe how they are seeking to strike the right balance between economic growth and price stability, it is the ghost of Benjamin Strong who hovers above him. It all sounds quite prosaically obvious now, but in 1922 it was a radical departure from more than two hundred years of central banking history.

Strong's policy of offsetting the impact of gold inflows on domestic credit conditions meant that as bullion came into the United States, it was, in effect, withdrawn from circulation. It was as if all this treasure that had been so painfully mined from the depths of the earth was being reburied.

Strong's policy contained a fundamental contradiction. On the one hand, he advocated a worldwide return to the international gold standard. On the other, he was doing things that not only undermined the doctrine he claimed most to believe in, but also, by preventing the gold from being recycled to Europe, he was making it all the more difficult for Europe to contemplate rejoining America on the gold standard. It was a dilemma he was never able to resolve.

European bankers argued that the ma.s.sive bullion imbalance between their countries and the United States was a fundamental problem for the world and pressed for some mechanism to recycle some of this gold. "I do not intend another quarter to pa.s.s," wrote Norman to Strong in January 1924, "without seeing you face to face, and asking you how in the name of heaven the Federal Reserve System and the United States Treasury are going to use their gold reserves."

KEYNES WAS THE first to recognize and articulate that, for all the public rhetoric about reinstating the gold standard, the new arrangements were in fact very different from the hallowed and automatic prewar mechanism. As he put it in the Tract, Tract, "A dollar standard was set up on the pedestal of the Golden Calf. For the past two years, the US has pretended to maintain a gold standard. In fact it has established a dollar standard." "A dollar standard was set up on the pedestal of the Golden Calf. For the past two years, the US has pretended to maintain a gold standard. In fact it has established a dollar standard."

It meant, in effect, that the Federal Reserve was so flush with gold that it had gone from being the central bank of the United States to being the central bank of the entire industrial world. Keynes's main concern was that Britain and other major European countries would find themselves being dictated to by a Fed that focused primarily on the needs of the domestic U.S. economy, yoking the gold-starved Europeans to U.S. credit policy. Strong was in the process of constructing a one-legged gold standard, whose European limb would be firmly tied to cla.s.sical rules while the American limb would be run by the Fed according to its own set of goals and constraints.

Keynes would have been even more horrified had he probed further into how the Fed operated and the character of the men who ran it. The Federal Reserve Act of 1913 had been a political compromise. Decisions about the level of interest rates and credit conditions were vested in the hands of the twelve banker-dominated regional reserve banks. This network was overseen by an eight-member central Board of Governors, all presidential appointees based in Washington. Broadly speaking, only the reserve banks could initiate policies, but these policies had to be approved by the Board.

It was not surprising that there should have been a certain amount of jockeying for control within the system. The precise locus of authority was ambiguous, and too many big egos-twelve governors of the reserve banks; the six political appointees on the Federal Reserve Board; the secretary of the treasury and the comptroller of the currency, both ex-officio members of the Board-were jostling for power.

From the start, the Board in Washington was an organization of unclear purpose and mandate. When it was created in 1913, Wilson conceived of it as a regulatory agency standing as a watchdog over the various regional reserve banks. He believed, therefore, that it should be comprised of individuals from outside banking. But he was unwilling to give it much stature. When the first governors of the Board complained to the president that the State Department expert on protocol had decided that as the most recently created of the government agencies, they should come last in social precedence, Wilson had replied that as far as he was concerned, "they might come right after the fire department."

The Board did not even have its own quarters but operated from a dark and dreary suite of offices on the top floor of the Treasury Building, from which its long and narrow boardroom overlooked the grimy interior court. Members salaries were typical of the civil service, considerably lower than private sector compensation and even much less than the pay of the governors of the regional Federal Reserve banks. Not surprisingly, the Board found it hard to attract good people-on one occasion six different candidates turned down an offer of a position before someone could be induced to accept.

As a result, the Board was, in J. K. Galbraith's description, "a body of startling incompetence." In 1923, the chairman was Daniel Crissinger. Born in a log cabin in Marion, Ohio, he was a local eminence, a lawyer and banker who had risen to the position of general counsel of the Marion Steam Shovel Company and had twice run for Congress, albeit unsuccessfully. He also had the fortune to have been one of Warren Harding's boyhood chums and, though by all accounts "utterly devoid of global or economic banking sense," was appointed comptroller of the currency in 1922 after his old friend had become president. The following year the president elevated him to the chair of the Board.

Besides its chairman and its two ex-officio members, the Board comprised five other governors, carefully selected not for their expertise but to ensure due representation for the different regions of the country. From Memphis, Tennessee, came George Roosa James, a dry goods merchant, a man of great energy, something of a diamond in the rough. His economic ideas, however, ran on the eccentric side. Firmly rooted in the past, he held that the basic foundation of the economy lay with the horse, the mule, and hay, and that the decay of the nation had begun with the advent of the automobile. the Board comprised five other governors, carefully selected not for their expertise but to ensure due representation for the different regions of the country. From Memphis, Tennessee, came George Roosa James, a dry goods merchant, a man of great energy, something of a diamond in the rough. His economic ideas, however, ran on the eccentric side. Firmly rooted in the past, he held that the basic foundation of the economy lay with the horse, the mule, and hay, and that the decay of the nation had begun with the advent of the automobile.

From Iowa came Edward Cunningham, who had started life as a dirt farmer and gone on to become Speaker of the Iowa legislature; from Poughkeepsie, New York, came Edmund Platt, a local newspaper publisher, who had entered politics as a member of the town's board of water commissioners and gone on to serve as its three-term Republican congressman. Boston furnished George Hamlin, longest serving of the governors, having been appointed chairman by Woodrow Wilson in 1914. By profession a lawyer, he had run unsuccessfully for governor of Ma.s.sachusetts in 1902 and 1910-a failed political career, it seems, was not an impediment, indeed was almost a qualification, for Board membership.

One member, however, who could legitimately claim some relevant expertise was Dr. Adolph Miller. Having studied economics at Harvard, he had been a professor at the University of California at Berkeley for twenty-five years. A deeply insecure man, he resented that his qualifications were not fully appreciated by his colleagues-they in turn tended to dismiss him as an ivory-tower theoretician with no practical experience. He liked to argue, and when his colleagues grew weary of the interminable wrangling, would begin to argue with himself. Not surprisingly, he was often confused and indecisive, with a tendency to adopt extremely dogmatic but contradictory positions on many topics. He had also developed a particular animus against Strong, resenting the younger man's influence and authority.

It did not help that Miller had learned his economics at a time when monetary economics, as a discipline, was very much in its infancy, thus leading him to espouse a series of outmoded beliefs about the way monetary policy was supposed to work. Among these was the now defunct doctrine of "real bills," that as long as the Federal Reserve and commercial banks restricted themselves to providing only short-term credit to finance inventories, nothing much could go wrong.

Faced with overseers such as this, it was not surprising that Strong was able to step into the vacuum of leadership and dominate the inst.i.tution. Unlike his nominal superiors, he made a concerted attempt-particularly during those many trips to Europe-to educate himself about central banking. It was he, for example, who was most responsible for introducing the biggest innovation in the way the Fed operated-so-called open market operations. When the Fed was conceived, it was a.s.sumed that it would primarily influence credit conditions by changes in its discount rate, the interest rate it charged on loans to member banks. By the early 1920s, this technique was proving to be too pa.s.sive, depending, as it did, for its impact on how much or how little bankers were willing to borrow at the discount window. Strong recognized that by buying or selling government securities from its portfolio, the Fed could directly and immediately alter the quant.i.ty of money flowing through the banking system.

It was inevitable that control of open market operations should become the object of an intense power struggle. The purchase and sale of securities out of their portfolios had initially been left to the reserve banks; but in 1923, the Board, recognizing the potency of the new tool, tried to take charge by requiring the committee that made these decisions to operate under its umbrella. Strong was away in Colorado at the time, recuperating from his bout of tuberculosis of the throat. He was furious. "I'll see them d.a.m.ned before I'd be dismissed by that timid bunch!" he wrote to one of his fellow governors. Eventually, though, he did acquiesce in giving the Board oversight over such operations. But as the most knowledgeable official on the new open market committee, he was easily able to call the shots on virtually all decisions.

In the process he stepped on a lot of toes, not concealing his impatience with the members of the Board. Some complained that he had an overblown sense of his own abilities, that he was too confrontational, that he lacked judgment, particularly about people. But as the intellectual leader of the Federal Reserve, he had acquired a large following within the organization and was "worshipped" by the younger men.

If there was one problem with this whole process of making monetary policy, it was that it all depended too heavily on Strong-on his judgment, his skill, and his insight. He was too autocratic, operated on his own too much, and did not spend the time to build a consensus through the whole system. As a result, the rationale for many of his decisions was misinterpreted and his motives were constantly questioned. His failure to inst.i.tutionalize policies and the thinking behind them meant that once he was no longer around, the Fed would become paralyzed by internal conflicts.

Keynes once compared the role of the Bank of England under the prewar system to that of the "conductor of an orchestra." Even though the Bank had then been administered by a club of old and established City patricians, the gold standard had been managed well, in part because circ.u.mstances were so favorable, in part because the directors of the Bank, however dull and unimaginative, were solid. After the war, as the world struggled to emerge from economic chaos, with currencies still in turmoil and gold in short supply everywhere outside America, it did not bode well that the new "conductor of the orchestra," the Federal Reserve, was a deeply divided organization that did not fully realize the role that had been thrust upon it and, but for Strong, would have been in the hands of a motley crew of small-town businessmen and minor-league political hacks with little expertise in finance or central banking.

PART THREE.

SOWING A NEW WIND.

1923-28.

10. A BRIDGE BETWEEN CHAOS AND HOPE.

Germany: 1923 Let me issue and control a nation's money and I care not who writes the laws.

-MAYER AMSCHEL ROTHSCHILD (1744-1812), founder of the House of Rothschild

AT 10:00 p.m. on November 8, 1923, two men could have been seen arriving at the Hotel Continental in Berlin for an intimate dinner in one of its private dining rooms. Each was in his own way a caricature of a type of German and could almost have come from central casting. The tall, thin figure with the clipped military mustache, hair cut short and parted very precisely in the center, was Hjalmar Schacht, now one of the most prominent bankers in Berlin, a director and board member of the Danatbank, third largest in Germany.

The other was short and fat, with an enormous head, his bloated face pasty from overindulgence and lack of exercise. With his easy smile and gregarious manner, he looked like a cla.s.sic lower-cla.s.s Berliner, crude, brash, but good-hearted. This was Gustav Stresemann, who just three months before had become chancellor of Germany. He was indeed what he appeared to be: a Berliner from the lower middle cla.s.ses, son of an innkeeper and beer distributor, though he had himself received a doctorate in economics from the University of Berlin, and had been a professional politician and corporate lobbyist since the age of twenty-two.

November 9, the next day, was the fifth anniversary of the flight of the kaiser. The night before, the Soviet emba.s.sy had hosted a grand party to celebrate the joint anniversaries of its own revolution and that of Germany, but Stresemann had excused himself on the grounds of state business. For the last two days, he had been locked in conference with members of his cabinet trying to find a way of averting the country's imminent bankruptcy.

On November 5, the price of a two-kilo loaf of bread had soared from 20 billion marks to 140 billion, sparking off nationwide riots. In Berlin, thousands of men and women had paraded the streets, shouting "Bread and work!" Over a thousand shops-bakeries, butchers, and even clothing stores-had been looted. Even in the city's chic west end, cars had been held up and the occupants robbed. In the heavily Jewish areas to the east around the Alexanderplatz, anyone who was known to be Jewish or "looked Jewish" had been attacked by gangs of young hoodlums. The worst violence was directed at Galician Jews, many of whom had their distinctive beards scissored off or their clothes ripped away. The Borse, the stock exchange, had come under siege by a mob shouting, "Kill the Borse Jews."

But by the evening of November 8, the streets were at last quiet, the mobs dispersed at bayonet point by military police. Heavily armed Prussian State Police in green uniforms now patrolled the city. After an abnormally hot Indian summer, the weather had turned extremely cold. That night, it had begun to rain, making life even more difficult for those innumerable Berliners forced to queue up outside the munic.i.p.al food kitchens and public feeding stations spread across the city.

The Hotel Continental was located in the center of Berlin, just off the tree-lined boulevard of Unter den Linden. Though not one of the major hotels, it was conveniently close to the Reichstag and sufficiently discreet and un.o.btrusive for Schacht and Stresemann to meet without drawing too much attention to themselves. Neither would have wished to be seen at one of the great fashionable meeting places, the Adlon on Pariserplatz or the Bristol on Unter den Linden, among all the nouveaux riches-the so-called Raffkes and Schiebers, fat, coa.r.s.e men who had made their money from profiteering during those last few feverish years and who could always be found in the big hotels, drinking champagne and gorging on oysters and caviar.

Despite the riots and the rain, the infamously louche and tawdry nightlife of Berlin-that new "Babylon of the world"-continued unabated. On the Friedrichstra.s.se and along Kurfurstendamm, the bars and dance halls were, as always, full. As on every night, hordes of prost.i.tutes of both s.e.xes-there were said to be a hundred thousand of them in Berlin alone-paraded outside in the strangest and most exotic costumes. "A kind of madness" had taken hold of the city, unhinging the whole society. Fortunes were made overnight and as quickly lost or dissipated. Those with money, desperate to be rid of it before it became worthless, indulged in giddy frenzies of spending, while those without sold what few possessions remained to them, including their bodies, in the struggle to survive. A quarter of the city's schoolchildren suffered from malnutrition.

Berlin had never been an elegant city. Before the war, people thought that it was too close a reflection of the personality of its emperor-brash, self-important, and vulgar-the "German Chicago," Mark Twain had called it. But it had rightly prided itself on being the cleanest and most modern metropolis in Europe. Now it was shabby and going to seed, faded and run down like a "stone-grey corpse," infested by "beggars, wh.o.r.es, invalids and fat-necked speculators," its streets crowded by "legless war veterans riding the sidewalks on rolling planks" and by stunted, bowlegged children bent out of shape by rickets.

STRESEMANN HAD BEEN called upon to form a government that August, when the previous coalition had collapsed, the sixth to fall in five years. He was thought to be the one man politically skillful enough to be able to bring together all the democratic parties-the Socialists, the Catholics, the liberals of the center-into a "Great Coalition" that could try to come to grips with a Germany on the verge of disintegration.

He had had not one but two improbable political careers. Before the war, despite his lower-middle-cla.s.s background-which twice led the kaiser to snub him conspicuously by publicly refusing to shake hands-he had been an ardent monarchist, a fervent militarist and, as head of the National Liberal Party in the Reichstag, a blind supporter of the military during the war. Known as "Ludendorff's young man" because of his loyalty to the Imperial High Command, he had been an advocate of the whole nationalist agenda-annexation, German expansion, and the campaign of unrestricted submarine warfare that had so angered the Americans. When the military broke down at the end of the war, Stresemann had been left, like so many other politicians of the imperial era, humiliated and discredited. Though he was still only forty years old, his political career seemed to be over. But in the five years since the revolution, he had steadily rebuilt his political image, transforming himself from a jingoistic warmonger to a trusted pillar of the new democracy, though many believed that his conversion was a sham.

Stresemann took over a country in deep crisis. The year 1923 had seen an oppressively hot summer of riots and strikes across a Germany genuinely close to breaking apart. In Saxony, the Communists had threatened to secede as an independent state, while in the south, the Bavarian government was being a.s.sailed from the right.

Despite his genial and sentimental exterior, Stresemann was a realist who had come to power determined to end the nightmare. In his first few weeks in office, he had the Reichstag approve an act empowering him to govern by decree; suspended the campaign of pa.s.sive resistance in the Ruhr, which was costing the government $10 million a day; and declared a state of emergency that gave the army the necessary authority to act against secessionist states.

Recognizing that the political breakdown had its roots in the dislocations and chaos of rampant hyperinflation, Stresemann then turned his attention to the monetary questions. Tax revenues at the time accounted for less than 10 percent of government expenditures, and the gap was being filled by printing money.

Stresemann had invited Schacht to dinner that night to try to persuade him to accept the position of currency commissioner, a new post with responsibility for reforming the whole German currency. It would make Schacht the financial czar of Germany, with more power than even the minister of finance.

The two had known each other for more than twenty years. They socialized in the same circles and were both members of the Berliner Mittwochgesellschaft, the Wednesday Society, a select discussion club restricted to eighty-five members and founded in 1915. Stresemann, who thought highly of Schacht, had been trying to find a position for him in the new administration for some weeks. The previous month, during his first cabinet reshuffle, he had even tried to appoint Schacht minister of finance; but the night before he was to submit his new list of ministers to President Friedrich Ebert, he had received a letter from a high official in the ministry expressing grave doubts about Schacht's suitability for the position, raising the old questions about Schacht's wartime record and hinting at ethical improprieties and corruption. At the last minute, Stresemann had been compelled to drop Schacht's name from his proposed cabinet.

For Schacht, the new opportunity could not have come at a better time. Now independently wealthy, he was eager to enter public life. Though he owed much of his fortune to Jacob Goldschmidt, he viewed his young a.s.sociate's deal making as dangerous. Increasingly sidelined within Danatbank, he had begun looking for a new challenge.21 He would later describe life that summer as "living on the edge of a volcano." The biggest danger in his view was a Bolshevik revolution. But as the political crisis began to reach a crescendo, he remained convinced that some great opportunity would present itself to him.

At the end of the summer, he sent his wife, Luise; his twenty-year-old daughter, Inge; and his thirteen-year-old son, Jens, to the safety of Switzerland. He had been hoping that the new government would offer him a position and he wanted to be able to take decisions without, as he put it, being "hindered by personal considerations were I to be drawn into the whirlpool." He knew that Luise, a fervent nationalist and right-wing radical with a "narrow Prussian outlook," was unlikely to be particularly welcoming to the left-wingers and democrats with whom he would have to a.s.sociate.

At 11:30 p.m., as the two men were finishing dinner and Schacht, a chain-smoker, had lit up, one of Stresemann's aides burst in. For weeks there had been rumors that the right-wing groups in Bavaria, one led by the local army and police commander, the other by a thirty-four-year-old ex-corporal named Adolf Hitler, were planning to seize power. They had now struck. Hitler, apparently working with the fallen general Erich Ludendorff, had taken over a Munich beer hall, drafted local political leaders to back him, and proclaiming the Berlin government deposed, was preparing to march on "that sink of iniquity." Reports were even filtering in that some army units in Munich had gone over to the rebels. Cutting short the dinner, Stresemann raced back to an emergency cabinet meeting at the Chancellery.

THE FOLLOWING MONDAY, November 12, Schacht received a call at his office on the Sc.h.i.n.kelplatz from Hans Luther, minister of finance, summoning him to the ministry, located in one of those grim official buildings on the Wilhelmstra.s.se. Hitler's attempt to seize power-the Beer Hall Putsch, as it was already being called-had collapsed within twenty-four hours, and the Stresemann government was getting back to business.

Short, fat, and completely bald, Luther had become a national hero when as mayor of the city of Essen in the Ruhr valley, he had defied occupying French and Belgian troops. But for all his exploits as a doughty little burgomaster, Luther was a cold, colorless, straitlaced figure, suspicious of Schacht's reputation for sailing too close to the wind. He had initially opposed Schacht's nomination, but when the two other bankers whom he first approached turned him down, he felt he had little choice.

That morning Luther formally offered Schacht the position of currency commissioner. Though Schacht pretended that he needed time to think the matter over, when Luther demanded an immediate reply, he accepted with, as one historian describes it, "an enthusiasm suitable to the as-yet-to-be revealed dimensions of his ambition."

Schacht came to the job with an array of qualifications. He was well known and admired in foreign banking circles, an attribute that would become very important when Germany had to go through its next cycle of wrangling over reparations. He was supported by the center and the left. In addition, it was rumored that Jacob Goldschmidt, powerful in Democratic Party circles and keen to oust Schacht from the Danatbank, was actively lobbying to kick him upstairs.

The post he a.s.sumed carried with it unprecedented powers. He was given cabinet rank; was to be invited to all its meetings; and most important, had the right of veto over any measures that had implications for the currency, a veto that could only be overridden by a majority of the cabinet.

Less grandly, for his office he was provided with a room in the back of the Finance Ministry that had once been a broom closet. It was dark, confined, and bare except for a writing table and a telephone. He agreed to take no salary, insisting that his $100 a month go to supplement the meager official $50 a month of his secretary, Fraulein Steff.e.c.k, whom he had brought over from the Danatbank and who was his single direct employee.

The plan was to introduce a totally new currency, the Rentenmark, to be backed not by gold but by land. The bank issuing the new currency was granted a "mortgage" on all agricultural and industrial property, on which it could impose an annual levy of 5 percent-in effect, a tax on commercial real estate.

Despite his new position, Schacht was as skeptical about the new plan's chances of success as almost everyone else in Germany. From the very first, he had scoffed at the idea of a land-based currency as a pure confidence trick; currencies had to be backed by a highly liquid, easily transferable, internationally acceptable a.s.set, such as gold. He found it hard to believe that someone being paid in the new currency would derive any comfort from the theoretical promise that those currency notes were ultimately convertible into some slab of inaccessible Thuringian woodland or Bavarian pasture or perhaps of a Communist-riddled Saar factory.

During the debate on the various currency reform plans, Schacht had forthrightly argued for gold as the foundation for a new currency. While no one could challenge the theoretical basis of his logic, the fatal difficulty had been that Germany simply did not have enough gold for the job. Before the war, the country had had a circulating currency of $1.5 billion, backed by just under $1 billion in gold. After five years of reparations and currency collapse, less than $150 million in gold remained. Moreover, the modest amount Germany did possess was in the hands of the Reichsbank, whose president, Rudolf von Havenstein, had been adamant that he would not part with an ounce to support something over which he had no control. While Schacht, usually a realist, had suggested that Germany try to build up its gold reserves by borrowing abroad, few people believed that a country that had defaulted on reparations the previous year and was now partly occupied by foreign troops would get even a hearing from international bankers.

The most important, perhaps the defining, characteristic of the new currency was not that it theoretically rested on land, but that the amount to be issued was to be rigidly fixed at 2.4 billion Rentenmarks, equivalent to around $600 million. Grasping that the key to its credibility was to keep it sufficiently scarce, Schacht was determined to ensure that the amount in circulation did not exceed its statutory ceiling under any circ.u.mstances. And though he encountered considerable political pressure to relent, including from his cabinet colleagues, he stuck to his position. He was obstinate, almost brutal, about turning down loan requests from everyone-government agencies, munic.i.p.alities, banks, or big industrialists.

Fraulein Steff.e.c.k has left a vivid picture of Schacht in those first few days: He sat on his chair and smoked in his little dark room at the Ministry of Finance, which still smelled of old floor cloths. Did he read letters? No, he read no letters. Did he write letters? No, he wrote no letters. But he telephoned a great deal-he telephoned in every direction and to every German and international place that had anything to with money and foreign exchange. And he smoked. We did not eat much during that time. We usually went home late, often by the last suburban train, traveling third cla.s.s. Apart from that he did nothing.

He took great pride in this portrait, which he never tired of repeating. He relished the image it evoked of the maverick financial genius operating masterfully on his own where established bankers had failed.

For VON HAVENSTEIN, the news of Schacht's appointment was the final humiliation. Though for the last five years he had presided over the single greatest debas.e.m.e.nt of a currency in history, he still refused to accept responsibility for the debacle. He kept insisting that it was not his fault but the result of government mismanagement and the Allies' extortionary demands.

When Stresemann came to power in August 1923, he tried to persuade Von Havenstein to go of his own accord, arguing that the public had lost all confidence in the currency, and that to reverse this required not just a new medium of exchange but a new president of the Reichsbank. Von Havenstein had categorically refused. By November, the chorus of demands that he resign had spread all the way across the political spectrum-everyone except the furthest-right nationalists. Only a few days earlier the leading industrialists had branded him the "father of the inflation." But the Reichsbank Autonomy Law of July 1922-ironically enacted at the insistence of the British, who hoped, by making the Reichsbank independent of the government, to curb inflation-had given the chief architect of inflation tenure for life.

No one could understand why Von Havenstein, who prided himself on his sense of service, clung so desperately and so humiliatingly to office in the face of such clamor. But he kept repeating that if he went, things would only get worse-how, very few people could see. In many ways it was precisely his pride as a public official that prevented him from resigning and thus acknowledging responsibility for the destruction of the mark and, with it, the savings of so many G.o.d-fearing Germans like himself. The most he would concede was that he might resign after a decent interval of several months so as to "preserve his honor."

Saddled with Von Havenstein, Stresemann had simply bypa.s.sed him by creating the independent Currency Commissionership outside of the Reichsbank. And so, when the new currency was introduced on November 15, 1923, Germany found itself in the curious position of having two official currencies-the old Reichsmark and the new Rentenmark-circulating side by side, issued by two uniquely parallel central banks. At one end of town was Schacht, operating from his converted broom closet; at the other, Von Havenstein, holed up and increasingly isolated and irrelevant in the Reichsbank's imposing red sandstone building on Jagerstra.s.se. Although the Reichsbank had now stopped providing money to the government, its printing presses still continued to roll out trillions of Reichsmarks to private businesses.

Neither Schacht nor Von Havenstein made any attempt to communicate with the other. The contrast between the two could not have been greater-Von Havenstein, a true gentleman of the old school, kind, courteous, but completely out of his depth; and Schacht, the arrogant upstart, quite prepared to confront the financial establishment, and not caring on whose toes he trod.

The whole justification for the new currency was to provide a stable alternative to the collapsed Reichsmark. The question immediately arose: At what rate could people convert their Reichsmarks into Rentenmarks? On November 12, the Reichsmark was trading at 630 billion to the dollar. Some argued that the rate of conversion should be fixed at that point, but Schacht decided to wait. The black market price was still falling, and he wished to allow the selling to exhaust itself before he committed to a rate of conversion. Every day the Reichsmark plunged further, and every day he insisted on holding back. On November 14, when it fell to 1.3 trillion, he did nothing. A day later, it was at 2.5 trillion and still he sat on his hands. Finally, on November 20, when the Reichsmark stood, if that is the word, at 4.2 trillion to the dollar, he fixed the conversion rate at 1 trillion Reichsmarks to a Rentenmark.

The decision to wait those extra days, allowing the old currency to sink by another 80 percent, was a brilliant tactical move. The Reichsmark became so worthless that the government was able to buy back its many trillions of debt, valued at $30 billion when first issued, for only 190 million Rentenmarks, equivalent to about $45 million.22 For the next few days, marks, both new and old, continued to fall on the black market. On November 26, the Reichsmark was trading at 11 trillion to the dollar in Cologne. Then the strangest thing began to happen. The exchange rate began to reverse itself. By December 10, it was back at 4.2 trillion to the dollar. Within a few days prices stabilized.

When prices were so insanely rising, the average German had done everything he could to get rid of any cash he received as fast as possible. Now this spiral reversed itself. As prices began to hold and then fall, it became profitable to hang on to cash. Farmers, their confidence in money restored, began bringing produce to market, food reappeared in the shops, and those interminable queues began to melt away. Lord d'Abernon, the British amba.s.sador, wrote of the "astonishing appeas.e.m.e.nt and relief brought about by a touch of the magical wand of "Currency Stability. . . . The economic detente has brought in its train political pacification-dictatorships and putsches are no longer discussed, and even the extreme parties have ceased, for the moment, from troubling. "

Not all of this was Schacht's doing. Stresemann and his cabinet colleagues backed the Rentenmark with a series of budgetary measures, suspending all subsidy payments to workers in the Ruhr, firing a quarter of the government workforce, and indexing all taxes to inflation, thus eliminating the incentive for taxpayers to delay payment. By January 1924, the budget was balanced. But it was Schacht who received the prime credit, feted in the press as "The Wizard" or the "Miracle Man."

MAX WARBURG ONCE remarked that he supported Schacht because "he always had good luck." That good fortune once more manifested itself. In early November, Von Havenstein took a few days' leave of absence, in order to get out of Berlin during the humiliation of Schacht's appointment; but he was also known to be seriously ill. In mid-November, he returned to his official apartment on the top floor of the Reichsbank. On November 20, the day that Schacht fixed the conversion value of the new currency, Von Havenstein after a late evening meeting with his board, suddenly collapsed and died of a heart attack at 3:30 a.m. He was sixty-six.

There was something terribly tragic about this deeply well-intentioned man. Not simply a dutiful bureaucrat, he was by all accounts a wonderful human being, to Max Warburg "an extraordinarily sympathetic personality, with an unbending sense of duty and honorable character." He was universally admired, kind, principled, and considerate, always living up to the highest virtues of his cla.s.s. During the war, while most households supplemented their rations by buying under the counter, Von Havenstein not only refused to use the black market, but even donated some of his own paltry bread and meat ration stamps to the poor. In the last year, however, he seemed to have lost his grip on reality-some said that the pressure he was under had made him prematurely senile-and few mourned his pa.s.sing.

While Schacht was Von Havenstein's logical successor, his unusual gift for making enemies continued to dog him. The strongest opposition came from within the Reichsbank board, which considered him an unprincipled interloper. The whole Belgian episode resurfaced all over again. The only rival candidate, however, was Karl Helfferich, who as wartime secretary of the treasury had been responsible for the disastrous policies that had left Germany so buried under debt. Helfferich's political views, allied to a taste for polemics, had propelled him into the vanguard of the right-wing nationalists. Because of his vicious ad hominem attacks on democratic politicians, he was blamed for instigating the wave of a.s.sa.s.sinations by paramilitary vigilantes. Whatever reservations politicians of the center and left who formed the backbone of the government might have held about Schacht, he was infinitely better than Helfferich. On December 20, Schacht was appointed president of the Reichsbank.

But despite the early success of the currency reform, Schacht was acutely aware that Germany's problems would not be solved by its efforts alone. Monetary stability was sustainable only while Germany could stall paying reparations. Ultimately, it would have to strike a deal with the Allies and resume some payments; and at that point, the mark would begin to plummet again.

Schacht believed, moreover, that the Rentenmark, based as it was on the fictional security of land, could only offer a temporary solution, "a bridge between chaos and hope," as he called it. Ultimately any stable German currency would have to be backed by gold. Since the Reichsbank held less than $100 million of the metal, wholly insufficient as the basis for an economy the size of Germany's, he would have to find some way of borrowing from abroad to bring the gold backing to an adequate level.

The United States was the obvious place to go-of all the powers after the war, it was the only one with surplus capital. But for the past three years it had withdrawn from European affairs, though there were some signs that it was waking up to the need to reengage. During his first few days in office, Schacht received some encouraging signals through many intermediaries, such as Gerard Vissering, the governor of the Nederlandische Bank, that Montagu Norman at the Bank of England was keen to find some way of bringing Germany back into the world economy. Norman had to be one of the keys to reestablishing Germany's credit abroad. No major bank, in either London or New York, would think of lending money to Germany without a nod from him. Schacht's first action after taking over at the Reichsbank was to bring his family back from Switzerland; the second was to arrange a meeting with Norman in London.