Lords of Finance
The Bankers who Broke the World

Liaquat Ahamed

published 2009

This summary focuses not on banker personalities but on economic troubles that began with World War I in 1914 and that followed that war to the Great Depression.

To pay for their warring, Europe's major powers printed a lot of money and suffered inflation. And to buy material from abroad, these countries spent their gold, much of it going to the country that was late getting into the war and benefiting from selling to the belligerents: the United States. This was imbalance Number One. Economies were on the gold standard and most of the gold was in the United States. The author, Ahamed, writes:

The concentration of the world's key precious metal in the United States had left the rest of the world with insufficient reserves to grease the machinery of trade. The world of the international gold standard had become like a poker table at which one player has accumulated all the chips, and the game simply cannot get back into play.

Imbalance Number Two was the decision to make Germany pay for the war – reparations payments. Ahamed writes of John Maynard Keynes, the young Cambridge don and his little book the Economic Consequences of the Peace:

Keynes argued that in order for Germany to earn the money to pay the Allies, it would have to sell more goods than it bought, and its trade partners would have to be willing to absorb this large influx of goods, with potentially crippling consequences for their own industries. It was therefore in the Allies' own self-interest to moderate their demands.

The United States was one of the countries that had inflated its economy. Of the major powers it was in the best financial shape, but it had allowed its money supply to expand 250 percent. Prices in the U.S. had doubled. The strategy to create a proper balance between paper money and what it was supposed to be worth in gold was to restrict the money supply. So credit was tightened. Interest rates were raised to 7 percent. As a result, the economy plunged into a recession. Bankruptcies soared. But by the end of 1921 prices had dropped to almost a third what they had been. Inflation ended and the economy began to recover. Writes Ahamed;

During the next seven years, the U.S. economy, led by new technologies such as automobiles and communications would experience an unprecedented period of strong growth and low inflation.

The British believed in maintaining the integrity of their currency. Britain refused to inflate its way out of debt, and it chose deflation as did the United States. By the end of 1922 prices in Britain were down 50 percent. But the British currency was overvalued by approximately 10 percent. Increase in value of British currency made it more difficult to sell British goods abroad, because these goods now cost more. Britain's cotton mills, coal mines and shipbuilding yards were priced out of world markets. Textile exports were half of what they had been in 1913. Unemployment in Britain remained the highest in Europe with its economy just limping along.

France, on the other hand, allowed some inflation, easing its abilty to cover its debts. French goods were less expensive abroad, and French exports boomed, and unemployment in France was a fraction what is was in Britain.

Rather than reducing its money supply and combating inflation, Germany printed more money, planning to pay off its international debts in cheaper currency. Hyper-inflation ensued. People spent their money as soon as they received it. With the value of Germany's currency rapidly declining, savings were wiped out and creditors ruined. The economy collapsed as nobody was willing to lend. Germany's currency, the Mark, reached 630 billion to the dollar on 12 November 1923. The government created what it hoped would be a commonly accepted value for the Mark independent of gold – which it lacked. As soon as the Mark stopped falling in value people stopped spending it as soon as they got it. They started saving again. With the return of confidence in money, farmers began sending their produce to market in more abundance, and the long lines for food in cities began to disappear.

The Germans set their exchange rate at 4.2 Marks to the dollar. Germany's goods were less expensive than British goods abroad. But Germany's ability to meet its reparations obligations remained a problem. The U.S. Secretary of State, Dawes, brought the major powers together in 1924, and they agreed on what was called the Dawes Plan. U.S. banks began lending a lot of money to Germany. Keynes described it as "a great circular flow of paper" across the Atlantic: From the U.S. money was lent to Germany, Germany transfered an equivalent amount to the Allies as reparation payments, the Allies sent money back to the United Stated government in the form of payment of debt incurred during World War I. Writes Ahamed, "No one was willing to predict what would happen once the music stopped."

U.S. stocks had been booming. The Dow Jones Industrial Average doubled between 1921 and 1925. Between 1922 and 1927 profits in the U.S. had risen 75 percent. General Motors was the most prominent stock, with a price-earning ration of less than 9, indicating a reasonable market price rather than a bubble in the making.

According to Ahamed, it was in the early summer of 1928 that the market "seemed to break free of its anchor to economic reality and began its flight into the outer reaches of make-believe. During the next fifteen months, the Dow went from 200 to a peak of 380, almost doubling in value." The British were also investing in U.S. stocks, and more British gold was on its way to the United States.

The bubble burst in October, 1929. Stock prices plummeted. But falling stock prices to more realistic values did not a depression make, and six weeks later (December 14, 1929) President Hoover declared that the volume of shopping indicated that the country was "back to normal."

In Europe, according to Ahamed, the hope was "that money that had been sucked into Wall Street would return home, alleviating the pressure on European gold reserves and allowing Britain and Germany easy credit with which to restart their economies."

That did not happen. Industrial production in 1929 had dropped 30 percent in the United States, 25 percent in Germany and 20 percent in Britain. The U.S. economy "had faced a similarly sharp decline in prices and production in 1921 and had bounced back," writes Ahamed. But in 1930-32 there was to be no bounce back.

In 1930 a decline in international trade was making matters worse. There was the Smoot-Hawley Act in June that raised U.S. tariffs, but "far more damaging," writes Ahamed, "was the collapse of capital flows." U.S. bankers pulled back from sending investments to Europe. With Europeans unable to gain currency by selling products to Americans, they had to pay for purchases from the U.S. in gold. Ahamed describes a complaint from Keynes, in Ahamed's words:

Because of investment fear, capital in search of security was flowing into those countries with already large gold reserves – such as the United States and France – and out of countries with only modest reserves – such as Britain and Germany.

In Britain the gold standard was blamed for a continuing drop in commodity despite cuts in interest rates. British banking was paralyzed, and in 1931 writes Ahamed, "...paralysis also began to affect the U.S. banking system. Bank failures arose, helped by runs on the banks. And this hurt the economy more as wealth was being withdrawn from the economy: hidden under mattresses, buried, put in safes, et cetera.

Germany's economy was hurt by the withdrawal of U.S. money. By the middle of 1930, "foreign lending throughout the world had collapsed." By early 1932, Germany's industrial production index had fallen 40 percent from its 1928 level, and a third of its labor force was unemployed.

Ahamed writes that Keynes, for the sake of sound credit creation and domestic price stability, had called for the gold standard to be replaced with managed money. The gold standard had kept the global economy unbalanced. Ahamed: "The gold standard had only worked in the late nineteenth century because new mining discoveries had fortuitously kept pace with economic growth. There was no guarantee that this accident of history would continue."

In Ahamed's final chapter he sums up the world economic collapse of 1929 to 1933, describing it as a "sequence of crises, ricocheting from one side of the Atlantic to the other." The first "shock" was the halt of capital from the U.S. to Germany. The second was the crash of the stock market in late 1929. Then from 1931 to 1933 there were the banking panics. He writes that "...the Fed stood passively aside while thousands of banks failed, thus permitting bank credit to contract by 40 percent." He adds:

In 1931, the evaporating confidence in European banks and currencies caused Germany and much of the rest of Central Europe to impose capital controls and default on their debt, leading to a contagion of fear that culminated in forcing Britain off the gold standard.