Norman had acquired his reputation for economic and financial perspicacity because he had been so right on so many things. Ever since the end of the war, he had been a fervent opponent of exacting reparations from Germany. Throughout the 1920s, he had raised the alarm that the world was running short of gold reserves. From an early stage, he had warned about the dangers of the stock market bubble in the United States.
But a few lonely voices insisted that it was he and the policies he espoused, especially his rigid, almost theological, belief in the benefits of the gold standard, that were to blame for the economic catastrophe that was overtaking the West. One of them was that of John Maynard Keynes. Another was that of Winston Churchill. A few days before Norman left for Canada on his enforced holiday, Churchill, who had lost most of his savings in the Wall Street crash two years earlier, wrote from Biarritz to his friend and former secretary Eddie Marsh, “Everyone I meet seems vaguely alarmed that something terrible is going to happen financially. . . . I hope we shall hang Montagu Norman if it does. I will certainly turn King’s evidence against him.”
THE COLLAPSE of the world economy from 1929 to 1933—now justly called the Great Depression
—was the seminal economic event of the twentieth century. No country escaped its clutches; for more than ten years the malaise that it brought in its wake hung over the world, poisoning every aspect of social and material life and crippling the future of a whole generation. From it flowed the turmoil of Europe in the “low dishonest decade” of the 1930s, the rise of Hitler and Nazism, and the eventual slide of much of the globe into a Second World War even more terrible than the First.
The story of the descent from the roaring boom of the twenties into the Great Depression can be told in many different ways. In this book, I have chosen to tell it by looking over the shoulders of the men in charge of the four principal central banks of the world: the Bank of England, the Federal Reserve System, the Reichsbank, and the Banque de France.
When the First World War ended in 1918, among its innumerable casualties was the world’s financial system. During the latter half of the nineteenth century, an elaborate machinery of international credit, centered in London, had been built upon the foundations of the gold standard and brought with it a remarkable expansion of trade and prosperity across the globe. In 1919, that machinery lay in ruins. Britain, France, and Germany were close to bankruptcy, their economies saddled with debt, their populations impoverished by rising prices, their currencies collapsing. Only the United States had emerged from the war economically stronger.
Governments then believed matters of finance were best left to bankers; and so the task of restoring the world’s finances fell into the hands of the central banks of the four major surviving powers: Britain, France, Germany, and the United States.
This book traces the efforts of these central bankers to reconstruct the system of international finance after the First World War. It describes how, for a brief period in the mid-1920s, they appeared to succeed: the world’s currencies were stabilized, capital began flowing freely across the globe, and economic growth resumed once again. But beneath the veneer of boomtown prosperity, cracks began to appear and the gold standard, which all had believed would provide an umbrella of stability, proved to be a straitjacket. The final chapters of the book describe the frantic and eventually futile attempts of central bankers as they struggled to prevent the whole world economy from plunging into the downward spiral of the Great Depression.
The 1920s were an era, like today’s, when central bankers were invested with unusual power and extraordinary prestige. Four men in particular dominate this story: at the Bank of England was the neurotic and enigmatic Montagu Norman; at the Banque de France, Émile Moreau, xenophobic and suspicious; at the Reichsbank, the rigid and arrogant but also brilliant and cunning Hjalmar Schacht; and finally, at the Federal Reserve Bank of New York, Benjamin Strong, whose veneer of energy and drive masked a deeply wounded and overburdened man.
These four characters were, for much of the decade, at the center of events. Their lives and careers provide a distinctive window into this period of economic history, which helps to focus the complex history of the 1920s—the whole sorry and poisonous story of the failed peace, of war debts and reparations, of hyperinflation, of hard times in Europe and bonanza in America, of the boom and then the ensuing bust—to a more human, and manageable, scale.
Each in his own way illuminates the national psyche of his time. Montagu Norman, with his quixotic reliance on his faulty intuition, embodied a Britain stuck in the past and not yet reconciled to its newly diminished standing in the world. Émile Moreau, in his insularity and rancor, reflected all too accurately a France that had turned inward to lick the terrible wounds of war. Benjamin Strong, the man of action, represented a new generation in America, actively engaged in bringing its financial muscle to bear in world affairs. Only Hjalmar Schacht, in his angry arrogance, seemed out of tune with the weak and defeated Germany for which he spoke, although perhaps he was simply expressing a hidden truth about the nation’s deeper mood.
There is also something very poignant in the contrast between the power these four men once exerted and their almost complete disappearance from the pages of history. Once styled by newspapers as the “World’s Most Exclusive Club,” these four once familiar names, lost under the rubble of time, now mean nothing to most people.
The 1920s were a time of transition. The curtain had come down on one age and a new age had yet to begin. Central banks were still privately owned, their key objectives to preserve the value of the currency and douse banking panics. They were only just beginning to espouse the notion that it was their responsibility to stabilize the economy.
During the nineteenth century, the governors of the Bank of England and the Banque de France were shadowy figures, well known in financial circles but otherwise out of the public eye. By contrast, in the 1920s, very much like today, central bankers became a major focus of public attention. Rumors of their decisions and secret meetings filled the daily press as they confronted many of the same economic issues and problems that their successors do today: dramatic movements in stock markets, volatile currencies, and great tides of capital spilling from one financial center to another.
They had to operate, however, in old-fashioned ways with only primitive tools and sources of information at their disposal. Economic statistics had only just begun to be collected. The bankers communicated by mail—at a time when a letter from New York to London took a week to arrive—or, in situations of real urgency, by cable. It was only in the very last stages of the drama that they could even contact one another on the telephone, and then only with some difficulty.
The tempo of life was also different. No one flew from one city to another. It was the golden age of the ocean liner when a transatlantic crossing took five days, and one traveled with one’s manservant, evening dress being de rigueur at dinner. It was an era when Benjamin Strong, head of the New York Federal Reserve, could disappear to Europe for four months without raising too many eyebrows—he would cross the Atlantic in May, spend the summer crisscrossing among the capitals of Europe consulting with his colleagues, take the occasional break at some of the more elegant spas and watering holes, and finally return to New York in September.
The world in which they operated was both cosmopolitan and curiously parochial. It was a society in which racial and national stereotypes were taken for granted as matters of fact rather than prejudice, a world in which Jack Morgan, son of the mighty Pierpont Morgan, might refuse to participate in a loan to Germany on the grounds that Germans were “second rate people” or oppose the appointment of Jews and Catholics to the Harvard Board of Overseers because “the Jew is always a Jew first and an American second, and the Roman Catholic, I fear, too often, a Papist first and an American second.” In finance, during the late nineteenth century and early twentieth century, whether in London or New York, Berlin or Paris, there was one great divide. On one side stood the big Anglo-Saxon banking firms: J. P. Morgan, Brown Brothers, Barings; on the other the Jewish concerns: the four branches of the Rothschilds, Lazards, the great German Jewish banking houses of Warburgs and Kuhn Loeb, and mavericks such as Sir Ernest Cassel. Though the WASPs were, like so many people in those days, casually anti-Semitic, the two groups treated each other with a wary respect. They were all, however, snobs who looked down on interlopers. It was a society that could be smug and complacent, indifferent to the problems of unemployment or poverty. Only in Germany—and that is part of this story—did those undercurrents of prejudice eventually become truly malevolent.
As I began writing of these four central bankers and the role each played in setting the world on the path toward the Great Depression, another figure kept appearing, almost intruding into the scene: John Maynard Keynes, the greatest economist of his generation, though only thirty-six when he first appears in 1919. During every act of the drama so painfully being played out, he refused to keep quiet, insisting on at least one monologue even if it was from offstage. Unlike the others, he was not a decision maker. In those years, he was simply an independent observer, a commentator. But at every twist and turn of the plot, there he was holding forth from the wings, with his irreverent and playful wit, his luminous and constantly questioning intellect, and above all his remarkable ability to be right.
Keynes proved to be a useful counterpoint to the other four in the story that follows. They were all great lords of finance, standard-bearers of an orthodoxy that seemed to imprison them. By contrast, Keynes was a gadfly, a Cambridge don, a self-made millionaire, a publisher, journalist, and best-selling author who was breaking free from the paralyzing consensus that would lead to such disaster. Though only a decade younger than the four grandees, he might have been born into an entirely different generation.
TO UNDERSTAND THE role of central bankers during the Great Depression, it is first necessary to understand what a central bank is and a little about how it operates. Central banks are mysterious institutions, the full details of their inner workings so arcane that very few outsiders, even economists, fully understand them. Boiled down to its essentials, a central bank is a bank that has been granted a monopoly over the issuance of currency.1 This power gives it the ability to regulate the price of credit—interest rates—and hence to determine how much money flows through the economy.
Despite their role as national institutions determining credit policy for their entire countries, in 1914 most central banks were still privately owned. They therefore occupied a strange hybrid zone, accountable primarily to their directors, who were mainly bankers, paying dividends to their shareholders, but given extraordinary powers for entirely nonprofit purposes. Unlike today, however, when central banks are required by law to promote price stability and full employment
, in 1914 the single most important, indeed overriding, objective of these institutions was to preserve the value of the currency.
At the time, all major currencies were on the gold standard, which tied a currency in value to a very specific quantity of gold. The pound sterling, for example, was defined as equivalent to 113 grains of pure gold, a grain being a unit of weight notionally equal to that of a typical grain taken from the middle of an ear of wheat. Similarly, the dollar was defined as 23.22 grains of gold of similar fineness. Since all currencies were fixed against gold, a corollary was that they were all fixed against one another. Thus there were 113/23.22 or $4.86 dollars to the pound. All paper money was legally obligated to be freely convertible into its gold equivalent, and each of the major central banks stood ready to exchange gold bullion for any amount of their own currencies.
Gold had been used as a form of currency for millennia. As of 1913, a little over $3 billion, about a quarter of the currency actually circulating around the world, consisted of gold coins, another 15 percent of silver, and the remaining 60 percent of paper money. Gold coinage, however, was only a part, and not the most important part, of the picture.
Most of the monetary gold in the world, almost two-thirds, did not circulate but lay buried deep underground, stacked up in the form of ingots in the vaults of banks. In each country, though every bank held some bullion, the bulk of the nation’s gold was concentrated in the vaults of the central bank. This hidden treasure provided the reserves for the banking system, determined the supply of money and credit within the economy, and served as the anchor for the gold standard.
While central banks had been granted the right to issue currency—in effect to print money—in order to ensure that that privilege was not abused, each one of them was required by law to maintain a certain quantity of bullion as backing for its paper money. These regulations varied from country to country. For example, at the Bank of England, the first $75 million equivalent of pounds that it printed were exempt, but any currency in excess of this amount had to be fully matched by gold. The Federal Reserve (the Fed), on the other hand, was required to have 40 percent of all the currency it issued on hand in gold—with no exemption floor. But varied as these regulations were, their ultimate effect was to tie the amount of each currency automatically and almost mechanically to its central banks’ gold reserves.
In order to control the flow of currency into the economy, the central bank varied interest rates. It was like turning the dials up or down a notch on a giant monetary thermostat. When gold accumulated in its vaults, it would reduce the cost of credit, encouraging consumers and businesses to borrow and thus pump more money into the system. By contrast, when gold was scarce, interest rates were raised, consumers and businesses cut back, and the amount of currency in circulation contracted.
Because the value of a currency was tied, by law, to a specific quantity of gold and because the amount of currency that could be issued was tied to the quantity of gold reserves, governments had to live within their means, and when strapped for cash, could not manipulate the value of the currency. Inflation therefore remained low. Joining the gold standard became a “badge of honor,” a signal that each subscribing government had pledged itself to a stable currency and orthodox financial policies. By 1914, fifty-nine countries had bound their currencies to gold.
Few people realized how fragile a system this was, built as it was on so narrow a base. The totality of gold ever mined in the whole world since the dawn of time was barely enough to fill a modest two-story town house. Moreover, new supplies were neither stable nor predictable, coming as they did in fits and starts and only by sheer coincidence arriving in sufficient quantities to meet the needs of the world economy. As a result, during periods when new gold finds were lean, such as between the California and Australian gold rushes of the 1850s and the discoveries in South Africa in the 1890s, prices of commodities fell across the world.
The gold standard was not without its critics. Many were simply cranks. Others, however, believed that allowing the growth of credit to be restricted by the amount of gold, especially during periods of falling prices, hurt producers and debtors—especially farmers, who were both.