Lords of Finance

June 18th, 2009 at 10:45 am David Frum | No Comments |

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Americans do not easily imagine the Great Depression as a global event. Yet if asked for a short answer to the question, rx “What caused the Depression, prostate ” the best reply would be: “the First World War”. The war left every former belligerent except the United States desperately indebted. Germany and Austria, find cut off from global finance, had borrowed massively from their own people. Russia and the minor belligerents had borrowed from France. France and Italy had borrowed from Britain. Britain had borrowed from America.

At war’s end, the French and Belgian demands for reparation had piled another load of debt onto the structure.

In 1945, the costs of war reconstruction would be paid by the United States. Such a thing was only remotely conceivable in 1918, for many reasons. Among them: Germany was not utterly vanquished at the end of the First World War. Defeated, yes, but resentful and capable of revenge. Another: the weakness of France and Britain was not so obvious in 1918 as in 1945. They still looked like great imperial powers, hardly in need of support from a United States that only half a decade before had been the world’s biggest debtor nation.

So: except for Russia – whose new Communist government repudiated its war debt outright – the former belligerents staggered into uneasy peace burdened by massive obligations. Germany and Austria wiped away their internal debt via inflation. They tried to evade their reparations debt by non-compliance. Evasion however led to French occupation of German industrial territories, however – and after 1923, everybody settled to a half decade’s labor to try to make the situation work.

Two things made the project especially difficult. The first was American protectionism. The congressional election of 1918 and the great landslide presidential election of 1920 restored to power the then-dominant Republican party. A big new tariff was imposed in 1922. That tariff greatly inhibited European exports to the world’s wealthiest consumer market.

Second – and this is the subject of Liaquat Ahamed’s valuable new book, Lords of Finance – every major power determined to return to the pre-war gold standard.

Here I have to take a digression from Ahamed’s story for the benefit of any gold fanciers in the readership. There is a tendency to describe gold as the natural money of man and the habitual money of European civilization. That distinction, if it is a distinction, belongs to silver, not gold. Gold coins of course were minted by every major power from classical times onward. But as Ahamed does point out, all the gold mined in the entire history of the world to 1914 would have fit in a small two-storey house. Gold was simply too rare and too valuable to fulfill any ordinary currency function. Cash for almost everybody almost all of the time meant silver.

What drove the shift to gold ironically was the development of paper money. As banking systems grew, it ceased to be necessary for people to keep large amounts of coin at hand. They could write each other checks against bank deposits – and nothing guaranteed credit like a bank store of gold. Language retained the memory of the silver origins of the units of account. A pound sterling had once literally meant a pound of metal. Ditto the French “livre” – from the Latin liber, hence our abbreviation lb.

But nobody ever actually saw a pound sterling. It existed in account books only. Over time, and as wealth and trade grew, it became ever more obviously impossible for men to move such weights of metal back and forth. They substituted checks instead, drawn on banks. To back these checks, bank kept stores of metal on hand. And the metal they preferred was the more valuable – and hence compact – gold.

In time, the value of the pound became fixed as a certain weight of gold. But well into the 19th century no other major currency was defined in those terms. It was only in the years after 1870 that Germany, France, and the United States adopted the British practice, and it was only in the “Belle Epoque” of 1896-1913 that the system ever really worked well.

The consequences of the attempt to reimpose gold after 1918 are the story of Liaquat Ahamed’s book. The Lords of Finance of his title are the central bankers who were handed the job. By and large, they made a mess of it, and Ahamed’s story recapitulates the sad story in a way that is both detailed and lively.

The central character in the story is Montagu Norman, governor of the Bank of England. Norman worked closely with Benjamin Strong, head of the New York Federal Reserve, more distantly with Hjalmar Schacht, head of the Reichsbank and Emile Moreau of the Bank of France. By modern standards, they were very odd men indeed – Norman verging on the positively eccentric. They operated at breathtakingly slow pace, communicating mostly by letter, taking lengthy vacations – or in Strong’s case, taking prolonged sabbaticals at mountain resorts to treat his tuberculosis.

These men, unelected and unaccountable wielded enormous power, power all the more breathtaking in that the Bank of England and the Bank of France remained privately owned institutions. They carried not only the prestige of the economist, but also the authority of representatives of a happier and more certain time.

For all of them, the resurrection of the prewar monetary system ranked as a supreme priority, both economic and moral. Unhappily for their future reputations, they had as a leading critic John Maynard Keynes, who combined a clever critique of their operations with memorable polemical savagery.

Ahamed understandably delights in quoting Keynes. By and large, he endorses Keynes’ critique of the unsuccessful monetary policy of the interwar years. Unlike Keynes, he brings a poignant appreciation to the task facing these central bankers: to restore a functioning global economy to a world that had not in fact made up its mind to live in peace. This poignant book inspires the thought: Maybe there are jobs just too big for bankers.

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