Lords of Finance: The Bankers Who Broke the World

04.12.09 / Uncategorized / Author: admin
Tags: Bankers, Finance:

Lords of Finance is about the central bankers who contributed to the Great Depression, in England, France, Germany, and the US. One of the author’s theses is that although we usually think of the Great Depression as having being caused by large impersonal forces beyond human control, in fact it was the discrete and wrong headed choices of these four bankers that helped bring down the international financial system, in large part by a stubborn adherence to the gold standard. So it makes one think of the recent financial crisis, and wonder if a handful of similar people could have made ‘better choices.’

It’s bracing stuff for economic history, even though you know sort of how the story resolves itself. Here the economics is very personal as the relationships between Strong (US Federal Reserve), Schact (Germany Reichsbank), Norman (Bank of England), and Moreau (Banque de France) determine the fate and character of what ultimately becomes the Great Depression–the opportunities lost, the bad policies, the pressure each faced at home from political considerations. In short, it is as exciting as a history of central banking could possibly be. It’s also interesting to see the ‘results’ of their work on history in their personal lives. Norman, for example, was very kind about sending Schact ‘care packages’ after the war when he was interned and put on trial at Nuremberg.

The basic gist of the story emerges after WWI, when countries who temporarily went off the gold standard then return as an article of economic faith. (Keynes appears and is blistering in his critique throughout.) The problem is, to get back on gold, countries’ currency must either devalue, or deflate, with particular consequences. Strong and Norman deflate, but Moreau and Schact devalue. Deflationary excess ruins the economy as prices shrink and consumers stop spending money waiting for prices to continue to go down. Devaluation risks hyperinflation, as it did in Germany, where the Reichsbank was printing trillions of marks a day and people would spend their wages as soon as they received them. The price of a cup of coffee would increase by the time you finished your first cup. The story of reparations and paying for them looms large in the story, the failure of financial ventures stressing the system, and the ultimate collapse in 1932 with bank ‘holidays’–the end of the banking system. Gold was an aggravating factor in what was really a series of crises which occurred in a short period of time that collectively caused the Great Depression, from hyperinflation in the 20s to the Stock Market crash.

The personal angles of these individuals is also interesting. Strong maintained US policy through sheer force of personality, to some detriment to his own health and personal life. His wife left him and he eventually died on the operating table from a lifelong health condition, probably aggravated by stress, in 1928. His demise sent the Federal Reserve system into a tailspin, as it was apparently his force of personality that held the early system together, as it was consistently challenged by insitutional deficiencies (e.g. each of the 12 reserve banks could propose policy, but the Board could only veto, and although all 12 were ‘equal’, some banks like the NY Fed, were much more important financially than others)

All four central bankers had personal relationships with each other, wanting to help each other out, but also had to respond to very different political agendas at home, in addition to keeping gold sacrosant.

I was reading an exerpt of ‘In Fed We Trust’ from the WSJ recently, and I was struck by the ‘personal being political’ issues which haven’t changed in almost 100 years. Bernanke’s struggle to cobble together a deal in Fall 2008, ultimately persauding Treasury to go to Congress for a bailout, eerily echoed Strong’s successor trying to put something together between the Hoover and Obama administrations.

Bernanke was in a similarly tough spot–in a way, similar to the ‘global warming problem’. That is, by the time you can definitvely point out where everybody agrees ‘hey this is a big effing problem’ across party lines, it’s too late and everybody fries. On Bernanke’s view he should have acted earlier, but, he suppposes, if he had acted much later, he’s pretty certain we would have seen Depression 2.0

That would not have been pretty at all. I’m not sure how long our society–and the world– would have functioned with the banks closed, credit cards useless, no access to mutual funds, the stock market shut down, etc. Not bloody long working with just the dollars in your pocket!

In this light, it’s funny to me how the California budget crisis sort of mirrors the issues of that period as well. Apparently this is much of their own making, with various propositions requiring certain funding by law which they cannot escape, plus some stringent budget balancing law (which sort of all ends up paralleling the Gold Standard). Apparently they’ve been able to cobble together a deal with alot of ‘one offs’ which will keep the State running another year. However, alot of the cuts are exactly the policies you *do not* want to enact in a recession–cutting jobs, salaries, etc. This is exactly the ‘orthodoxy’ Herbert Hoover was pursuing–balancing the budget–which itself helped aggravate the Depression. Hoover was educated at Stanford so maybe there’s a funny parallel there, too. But I don’t know alot about California budgetary politics and their actual constraints, so I am talking out of school on this one.

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Amazon Exclusive: Liaquat Ahamed on the Economic Climate

In December 1930, the great economist Maynard Keynes published an article in which he described the world as living in “the shadows of one of the greatest economic catastrophes in modern history.” The world was then 18 months into what would become the Great Depression. The stock market was down about 60%, profits had fallen in half and unemployed had climbed from 4% to about 10%.

If you take our present situation, 16 months into the current recession, we’re about at the same place. The stock market is down 50 to 60 percent, profits are down 50 percent, unemployment is up from 4.5% to over 8%.

Over the next 18 months between January 1930 and July 1932 the bottom fell out of the world economy. It did so because the authorities applied the wrong medicine to what was a very sick economy. They let the banking system go under, they tried to cut the budget deficit by curbing government expenditure and raising taxes, they refused to assist the European banking system, and they even raised interest rates. It was no wonder the global economy crumbled.

Luckily with the benefit of those lessons, we now know what not to do. This time the authorities are applying the right medicine: they have cut interest rates to zero and are keeping them there, they have saved the banking system from collapse and they have introduced the largest stimulus package in history.

And yet I cannot help worrying that the world economy may yet spiral downwards. There are two areas in particular that keep me up at night.

The first is the U.S. banking system. Back in the fall, the authorities managed to prevent a financial meltdown. People are not pulling money out of banks anymore—in fact, they are putting money in. The problem is that as a consequence of past bad loans, the banking system has lost a good part of its capital. There is no way that the economy can recover unless the banking system is recapitalized. While there are many technical issues about the best way to do this, most experts agree that it will not be done without a massive injection of public money, possibly as much as trillion from you and me, the taxpayer.

At the moment tax payers are so furious at the irresponsibility of the bankers who got us into this mess that they are in no mood to support yet more money to bail out banks. It is going to take an extraordinary act of political leadership to persuade the American public that unfortunately more money is necessary to solve this crisis.

The second area that keeps me up at night is Europe. During the real estate bubble years, the 13 countries of Eastern Europe that were once part of the Soviet empire had their own bubble. They now owe a gigantic .3 trillion dollars, much of which they won’t be able to pay. The burden will have to fall on the tax payers of Western Europe, especially Germany and France.

In the U.S. we at least have the national cohesion and the political machinery to get New Yorkers and Midwesterners to pay for the mistakes of Californian and Floridian homeowners or to bail out a bank based in North Carolina. There is no such mechanism in Europe. It is going to require political leadership of the highest order from the leaders of Germany and France to persuade their thrifty and prudent taxpayers to bail out foolhardy Austrian banks or Hungarian homeowners.

The Great Depression was largely caused by a failure of intellectual will—the men in charge simply did not understand how the economy worked. The risk this time round is that a failure of political will leads us into an economic cataclysm.

With penetrating insights for today, this vital history of the world economic collapse of the late 1920s offers unforgettable portraits of the four men whose personal and professional actions as heads of their respective central banks changed the course of the twentieth century

It is commonly believed that the Great Depression that began in 1929 resulted from a confluence of events beyond any one person’s or government’s control. In fact, as Liaquat Ahamed reveals, it was the decisions taken by a small number of central bankers that were the primary cause of the economic meltdown, the effects of which set the stage for World War II and reverberated for decades.

In Lords of Finance, we meet the neurotic and enigmatic Montagu Norman of the Bank of England, the xenophobic and suspicious Émile Moreau of the Banque de France, the arrogant yet brilliant Hjalmar Schacht of the Reichsbank, and Benjamin Strong of the Federal Reserve Bank of New York, whose façade of energy and drive masked a deeply wounded and overburdened man. After the First World War, these central bankers attempted to reconstruct the world of international finance. Despite their differences, they were united by a common fear—that the greatest threat to capitalism was inflation— and by a common vision that the solution was to turn back the clock and return the world to the gold standard.

For a brief period in the mid-1920s they appeared to have succeeded. The world’s currencies were stabilized and capital began flowing freely across the globe. But beneath the veneer of boom-town prosperity, cracks started to appear in the financial system. The gold standard that all had believed would provide an umbrella of stability proved to be a straitjacket, and the world economy began that terrible downward spiral known as the Great Depression.

As yet another period of economic turmoil makes headlines today, the Great Depression and the year 1929 remain the benchmark for true financial mayhem. Offering a new understanding of the global nature of financial crises, Lords of Finance is a potent reminder of the enormous impact that the decisions of central bankers can have, of their fallibility, and of the terrible human consequences that can result when they are wrong.

Available at Amazon

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