Ben Bernanke was Time magazine’s Person of the Year for 2009. A decade earlier, the magazine proclaimed Alan Greenspan, Robert Rubin and Lawrence Summers ‘The Committee to Save the World,’ when they were, respectively, Federal Reserve board chair, treasury secretary and deputy treasury secretary. But as a recent book shows, history is not always kind to those who are lionized in moments of crisis.
Liaquat Ahamed’s “Lords of Finance” is an excellent history of a chain of economic policy failures beginning during World War I that culminated in the financial crises of 1929-1933 and the ensuing Great Depression and Second World War. Ahamed chronicles how financial officials, as famous in their time as Greenspan or Bernanke, made crucial errors that doomed the world economy.
The financial lords referred to in the title are Benjamin Strong, Montagu Norman, Horace Greeley Hjalmar Schacht and Emile Moreau, respectively the leading central bankers of the United States, the United Kingdom, Germany and France during most of the period in question. And, as his subtitle “the bankers who broke the world” indicates, Ahamed blames these officials for the financial collapses and depression that led directly to World War II, the most destructive conflict in the history of humanity.
This is overly harsh. The four did make serious errors, but it was the domestic politics of their respective nations and their interlocking international relations that were the root causes of catastrophe. Even if they had used their positions of power more wisely, the historical forces became such that no set of individual monetary officials could have avoided disaster.
The fundamental problem was that World War I destroyed wealth and economic resources on an enormous scale. For four years, much of the output of the industrialized nations was consumed in making war. Millions of young men died. Farms, factories and mines were destroyed, particularly in Belgium and France.
France, Britain and Germany essentially bankrupted themselves in the process. The first two were able to secure loans from the United States, but repaying those loans threatened fiscal stress for decades.
The victors decided to fund part of this by forcing the losers to pay reparations. This had precedent. The Germans had forced France to pay after it lost the Franco-Prussian War and imposed harsh reparations on Russia when it dropped out of World War I in 1917.
But whatever the moral situation, Germany was forced to sign a treaty requiring it to pay reparations beyond its economic capacity to do so. The United States refused to forgive money owed it by France or Britain. Everything else in a tragic chain that led to the Great Depression, the rise of Adolf Hitler and another war stemmed from this situation.
This fundamental problem surfaced in many ways. Germany had hyperinflation in the early 1920s. Then, after its finances were stabilized, hot money flowed in from Britain and the United States, often loaned to local governments for projects in excess of their ability to repay.
Britain created a recession for itself by going back on the gold standard in 1925, immediately making British goods more expensive in export markets around the world.
In the United States, the recently established Federal Reserve tolerated a sharp recession immediately after the war as defense spending ended abruptly. Then, previewing the 1999-2009 decade, it fostered a boom through a combination of too much money growth and inadequate prudential supervision of bank lending practices. France hoarded gold, reducing liquidity in other markets, and remained intransigent on reparations.
For us, the October 1929 stock market crash touched off the Great Depression. We ignore a second blow that came in 1931 when an Austrian bank, Credit Anstalt, failed, triggering a financial crisis in Central Europe that turned into renewed economic chaos that brought Hitler to power two years later.
As Ahamed argues, the central banker’s blind adherence to the gold standard multiplied financial problems and transmitted them to other countries. They deserve sharp criticism.
But the failures extended far beyond them to the governments of their respective countries. Time and again, the domestic policy pressures of winning the next election or surviving through the immediate economic problem led governments in all the countries to pursue policies that were collectively suicidal in the long run.
Ironically, most of the reparations eventually were written off, as was much of the money owed the United States. All the countries eventually were forced off the gold standard, but only after much unnecessary economic and social suffering.
So what can we learn from this, 90 years later? One parallel jumps out. The United States is unable to overcome a political deadlock that leads to spiraling national debt. And so we keep borrowing abroad, especially from China.
Chinese leaders, fearful of political and social unrest that high unemployment would foster, continue to buy up U.S. dollars and with them, U.S. Treasury securities.
They do this to keep the U.S. dollar expensive and thus U.S. imports from China high. Officials in both countries recognize that the longer this goes on, the more likely it is to come to a bad end. But in neither country is there the effective political leadership needed to change things.
© 2010 Edward Lotterman
Chanarambie Consulting, Inc.