Three weeks later, the government with which he had broken split over the unemployment question and fell, the Socialists wanting to finance an expansion in unemployment benefits by more foreign borrowing, the center parties to cut the budget deficit. A new center-right coalition, excluding the Socialists, took office and was led by a new chancellor, Heinrich Brüning, a dour Catholic, former army officer, and staunch monarchist.
Unable to get anything through a divided parliament, Brüning was forced to rule by decree, moving Germany in a more authoritarian direction by his reliance on the constitution’s provisions for emergency powers. Defeated in the Reichstag, he had Von Hindenburg dissolve it and hold new elections in September 1930, two years early. The results came as an ugly shock. In a campaign dominated by the deteriorating economy, Hitler appealed across class lines, promising to reunite the nation, rebuild its prosperty, restore its position in the world, and purge the country of profiteers. He put a lid on some of his more extreme anti-Jewish rhetoric. Speaking at giant open-air rallies, many in sports stadiums lit by arrays of blazing torches, he mesmerized the tens of thousands who attended these events with his oratory. Meanwhile in the streets, his jack-booted paramilitary thugs, armed with truncheons and knuckledusters, clashed violently with Communists and Socialists. The Nazis won 6.4 million votes, and vaulted into second place in the Reichstag with 107 seats.
The election panicked the financial markets; an estimated $380 million, about half of Germany’s reserves, bolted. To halt the flight, the Reichsbank was forced to raise its rates, so that while in New York and Paris these stood at 2 percent, and in London at 3 percent, in Germany they went up to 5 percent. With prices falling at a rate of 7 percent per year, it meant that the effective cost of money had risen to 12 percent, gravely exacerbating the economic weakness.
As the economy lost ground, unemployment climbed, and the budget deficit widened, Brüning focused on balancing the budget. Unemployment benefits were restricted; salaries of all high federal and state officials, including the president’s, were slashed by 20 percent. Wages of lower-level officials were cut 6 percent; income taxes were raised, taxes on beer and tobacco increased, and new levies imposed on warehouses and mineral water. All of these measures made the Depression worse.
Germany was unusual in the degree of deflation that the government imposed on the economy. In the United States, the Hoover administration had cut taxes and allowed the budget to go from a surplus of $1 billion in 1929 to a deficit of $2 billion in 1931, 4 percent of GDP. Britain ran a deficit of $600 million in 1931, 2.5 percent of GDP. By contrast in Germany, even though revenues fell as activity faltered, expenditures were cut even more, and the deficit was actually reduced from an already modest $200 million to $100 million, less than 1 percent of GDP.
Brüning, who was now being called the “Hunger Chancellor,” would later claim that his austerity measures had been designed to prove to foreigners that Germany could no longer pay reparations, a reprise of the old perverse “hair-shirt” policy attempted in the early 1920s: to inflict so much damage on Germany’s economy that her creditors would be forced to reduce their demands.
Historians have debated whether the government had any alternative. Borrowing abroad was not an option. By the middle of 1930, foreign lending throughout the world had collapsed. Moreover, Germany had borrowed so much during the boom years, living by the standards of the time so high on the hog that when bad times finally arrived and it really needed the money, it had exhausted its credit lines and loans were no longer available.
The problem was made much worse by one of the unintended consequences of the Young Plan. Under the Dawes Plan before it, private commercial lenders had priority over reparations at a time of crisis. In effect, Germany’s public creditors, principally the governments of France, Belgium, and Britain, had to stand last in line. The Young Plan’s elimination of this “transfer protection,” which incidentally Schacht had tried to resist, put an end to the guarantee. In the event of a payments crisis, private lenders did not automatically move to the front of the line but had to wait their turn with the big governments. Not surprisingly, private foreign lending to Germany collapsed.
No longer able to borrow abroad, Germany could only have avoided the Brüning austerity package if the government had borrowed from the Reichsbank—in other words, financed its budget deficit by printing money. But memories of the hyperinflation of the early 1920s were too fresh. Moreover, the Dawes and Young plans severely limited the Reichsbank’s ability to buy government debt. The only way Germany could have followed such a policy was to cut loose from gold; and almost no one was ready for so drastic a move.
Out of office, Schacht was careful not to criticize Brüning’s domestic policies, perhaps in the hope that he might return to power as part of a conservative Nationalist government. At the time, he did not realize how lucky he was. The new government adopted many of the austerity policies that he himself was advocating, with catastrophic results. But he was able to watch from the sidelines while the German economy fell apart, remaining free from any blame.
He could not, however, keep silent about reparations. The idea that the way to escape them was to inflict a terrible recession on Germany was to him completely absurd. Though he spent the first few months of his retirement at his estate at Gühlen, he quickly became frustrated at his confinement. In the summer of 1930, he embarked on a worldwide speaking tour, beginning in Bucharest, and thence to Berne, Copenhagen, and Stockholm. In September, he departed for two months to the United States.
He made something of a splash in America. With his pince-nez and his distinctive hair en brosse, the “Iron Man” of Germany, as Time magazine labeled him, was immediately identifiable. He was certainly more familiar to the average reader of the London Times or the New York Times than any of the last few German chancellors. He traveled to over twenty cities, giving almost fifty talks to audiences of college students and professors, bankers and business associations, at private clubs and in public meetings.
Mostly he spoke about reparations, seeking to make his audiences understand German bitterness over the issue: “You must not think that if you treat people for ten years as the German people have been treated they will continue to smile.” Germany, with its GDP of $16 billion, exports of $3 billion, and an overhang of private foreign debt now amounting to $6 billion, simply could not afford to pay $500 million a year to France and Britain. In Cincinnati, he declared, “Reparations are the real cause of the world-wide economic depression.” Everywhere he went he was asked about the recent elections and Hitler. “If the German people are going to starve, there are going to be many more Hitlers,” he would reply. Back in Europe, when a Swedish journalist asked him, “What would you do if you were to become Chancellor tomorrow?” Schacht replied with no hesitation, “I would stop making payments of reparations that very day.”
In January 1931, he took his first tragic steps down the Faustian path. In December 1930, he had been introduced to Hermann Göring. Until then, despite his dealings with the Nationalist leader Hugenberg, he had had very little contact with the Nazis, whom he would later claim to have dismissed as a fringe group of rabble mongers. Nevertheless, Schacht’s wife was well known to hero-worship Hitler and was a devoted supporter of the party. In her diary, Bella Fromm, the diplomatic columnist of the Vossische Zeitung, recounts how she encountered the Schachts in February 1930 at the silver wedding reception of a prominent Berlin banker. Frau Schacht wore an expensive swastika of rubies and diamonds on her ample bosom and Fromm recorded the rumor that Schacht himself was “not above using the swastika as his insignia whenever he thinks it will suit his purpose.” That night he even told her, “Why not give the National Socialists a break? They seem pretty smart to me.”
The conversation during his evening with Göring focused on the “economic situation, the rise in unemployment figures, the timidity of German foreign policy,” and Schacht took to this “pleasant, urbane” man. On January 5, Göring invited Schacht, along with Fritz Thyssen, chairman of the giant United Steel Works, to meet Hitler at his modest apartment in a middle-class neighborhood of Berlin—Göring did not yet have access to the government money that would allow him to become the corrupt voluptuary of later years. The Nazi leader arrived after dinner dressed in the yellow and brown uniform of his paramilitary forces; Joseph Goebbels also showed up. Schacht admitted to being impressed. Hitler was surprisingly modest and unpretentious, especially for the leader of the second largest party in the country. During the next two hours, Hitler, “in spite of a hoarse, somewhat broken and not infrequently croaking voice,” dominated the discussion, doing 95 percent of the talking—about the restoration of Germany’s position in the world, about the need to get the six and a half million unemployed back to work, and how this could only be done by state intervention. Hitler was articulate, speaking without any “propagandist pathos,” but obviously “a born agitator.” It was a fateful encounter for the fascinated banker.
ARNOLD TOYNBEE, IN his magisterial review of the year’s events on behalf of the Royal Institute of International Affairs, would later compare the events of the summer of 1931 to the summer of 1914. Both began with relatively minor events far from the hub of the world that nevertheless set in train a cascade that plunged out of all control and brought down an entire world order. In 1914, it was the assassina
tion of the Austrian heir presumptive, the archduke Franz Ferdinand, at Sarajevo. In 1931, it was the failure of the Credit Anstalt, the oldest and largest bank in Austria.
On Friday, May 8, the Credit Anstalt, based in Vienna and founded in 1855 by the Rothschilds, with total assets of $250 million and 50 percent of the Austrian bank deposits, informed the government that it had been forced to book a loss of $20 million in its 1930 accounts, wiping out most of its equity. Not only was it Austria’s biggest bank, it was the most reputable—its board, presided over by Baron Louis de Rothschild of the Vienna branch of the family, included representatives of the Bank of England, the Guaranty Trust Company of New York, and M. M. Warburg and Co. of Hamburg. After a frantic weekend of secret meetings, the government made the problem public on Monday, May 11, at the same time announcing a rescue package of $15 million dollars, which it would borrow through the BIS.
Austria was a small country, about a tenth the size of Germany, with a population of fewer than seven million and a GDP of $1.5 billion. Nevertheless, the news burst like a bombshell upon the City of London and the Bank of England. By an odd coincidence, Schacht was staying with Norman at Thorpe Lodge when the story broke. Harry Siepmann, one of the governor’s principal senior advisers, knowing something of the scope of the tangled mess that lay behind the headlines, announced, “This, I think, is it, and it may well bring down the whole house of cards in which we have been living.”
Like many German banks, the Credit Anstalt made direct investments in industry, similar to those of a modern private equity firm. It was, however, especially vulnerable not only because it borrowed short-term money to finance what were long-term, highly illiquid, investments but also because it had an unusually large amount of foreign borrowing on its books—some $75 million out of a total deposit base of $250 million.
It had grown over the last decade by absorbing a series of failing small banks and, in 1929, had been further “persuaded” by the Austrian National Bank to take over the Bodencreditanstalt, its next largest rival, whose losses turned out to be gigantic. In order to compensate Credit Anstalt for saving the Austrian banking system by taking on the burden of a such a large bankrupt institution, the Austrian central bank had been funneling money secretly to it through London banks, a fact of which the Bank of England was well aware.
The announcement of the rescue package failed to stabilize the situation, perhaps because more people knew how deep the problems went than the government realized—when Credit Anstalt was finally wound up two years later, the accumulated losses amounted to $150 million. Over the next four days a run developed, not only on the Credit Anstalt but on all Austrian banks, which lost some $50 million in deposits, about 10 percent of the total. In an attempt to shore up its banking system, the Austrian National Bank followed Bagehot’s principle and lent freely, injecting an extra $50 million, which caused an overnight jump of 20 percent in the national money supply.
Norman had a soft spot for Austria. After the war, he had provided it with the first loan to stabilize its currency—for his services to the country he had been awarded the Grosse Goldene Ehrenzeichen (Grand Decoration of Honor in Gold) from the Austrian ambassador to the Court of Saint James, Baron Georg von und zu Franckenstein. For the next several days, having now discovered the remarkable advantages of international telephone calls, he was constantly on the line to Harrison in New York and Luther in Berlin. Fearing that a monetary breakdown in Austria would spread to neighboring countries, he was determined to mount an international rescue effort.
None of the central bankers had faced an international financial crisis before; they therefore had to make things up as they went along. In so doing they made two mistakes. Given the scale of the problem, they came up with far too little money; and believing that it was necessary to put together as international a consortium as possible, they did not act quickly enough. For all the frantic telephone calls, it took them three weeks to drum up the money, and then only came up with $15 million.
By the time the loans had been agreed to, the promised money had already been used up and the run on Austrian banks had become a run on the Austrian currency. The National Bank lost $40 million of its $110 million of gold reserves. Faced now with both a banking system under threat and a currency under siege, it now pleaded for another $20 million.
The crisis was made immeasurably more complicated by the politics of the situation. In March 1930, Germany and Austria had announced that they would form a customs union. Germany’s neighbors, in particular the French and the Czechs, remembering that the nineteenth-century Zollverein, the historic customs union among the states of the German Confederation, had been a prelude to German unification, and fearing that this might be the first step to Anschluss, union between Austria and Germany, had been agitating to block the move.
The French government now saw its opportunity. Indeed it helped to create it by secretly encouraging French banks to pull money out of Austria. By June 16, the situation was becoming more desperate by the hour. The cabinet, fearing the breakdown of law and order in Vienna, was on the verge of imposing a bank holiday. Austria was still waiting anxiously for the second loan when it received word that France had offered to provide it—but only if Austria would abandon the customs union. As if in an ultimatum, the Austrian government was given three hours to respond.
With its back to the wall, Austria might have accepted. In London, however, Norman was outraged at this blatant abuse of French monetary power in such a delicate financial situation and cabled that the Bank of England would provide the loan on its own. But if he thought he had succeeded in pricking the panic in its bud, he was mistaken.
ON JUNE 5, at 2.30 in the afternoon, Thomas Lamont put a call through to President Hoover. As soon as the Austrian crisis had broken, Germany had also begun to lose gold reserves. The contagion was not so much because Germany had a large amount of capital tied up in Austria, rather it was largely a matter of psychology. The world, which had never drawn much of a distinction between the banking situation in Berlin and that in Vienna, jumped to the conclusion that if the main Austrian bank was in such serious trouble, it was very possible that a German bank might soon follow. As money started escaping Germany, rumors circulated that Berlin might soon request a suspension of reparations. Lamont feared that to cope with the political turmoil and flight of capital that would ensue, Germany might impose exchange controls. With American institutions holding about a billion dollars in short-term credits to Germany, such a move could threaten the solvency of more than one U.S. bank.
Saying that he was about to make a suggestion that the president would “more than likely throw out of the window,” Lamont proposed that Hoover unilaterally declare a holiday on all payments on war debt and reparations. No European country could advance the idea, for it would immediately call into question its own credit, signaling to its creditors as he put it that “the jig is up.” Only the United States was in a position to take the lead. Hoover was initially unconvinced. “I will think about the matter” he told Lamont, “but politically it is quite impossible. Sitting in New York as you do, you have no idea what the sentiment of the country at large is on these intergovernmental debts. . . . Congress sees France piling up lots of gold, increasing armaments. . . .”