The Influence of Central Bankers on the World Economy

In Lords of Finance: 1929, The Great Depression, and the Bankers Who Broke the World, Liaquat Ahamed outlines how a plethora of banking and financial failures contributed to the greatest economic disaster in world history. In particular, Ahamed discusses the poor economic decisions made by the central bankers in the United States, France, Great Britain, and Germany – the four predominant economic powers at the time. He also outlines steps that could have been taken to prevent the Great Depression from being a global phenomenon, while also warning that a similar situation could occur again under similar circumstances. The most compelling aspect of the novel, however, is the fact that the decisions Montagu Norman, Benjamin Strong, Hjalmar Schacht, and Emile Moreau made leading up to the financial collapse are summarized, painting a picture of how the four unknowingly exacerbated the situation through poor decision making and an unsustainable reliance upon one another.

The first of the four bankers described in the book is Montagu Norman of Britain. Described as a strange and lonely man, Norman was originally a merchant banker before becoming the head of the Bank of England. He would preside over Britain following World War I, where the country would be straddled with massive war debts and austerity measures. Although Britain was previously the banking capital of the world, European countries, including Britain itself, were forced to borrow money from wherever possible to finance war expenditures and purchase raw goods, resulting in Britain owing the United States $5 billion following the war (Ahamed 1904). Complicating matters, Russia refused to pay the $2.5 billion it had borrowed from Britain following the Bolshevik Revolution.

By 1924, Britain had largely forgotten about its war debts due to a plan devised by the United States to lend money to Germany to pay off its war reparations. This allowed Britain to once again become prosperous economically. Not all was well across the pond, however, as the textile and coal markets had both dropped off considerably, leading to roughly a million and a quarter men to go without work. This came after a mistake was made by Norman in an attempt to keep the pound pegged to the gold standard.

It seemed as though the plan would succeed at first, as the price of the pound had gone from $3.20 to $4.30 in a short period of time (Ahamed 3211), but it also had many unintended consequences. Most importantly, it forced the British government to increase interest rates because they were having a hard time competing for gold with the United States, where it hard become highly concentrated following the war. However, the government and Montagu Norman refused to inflate its currency to pay off its debt because it did not want its currency to collapse, ultimately leading to a spike in unemployment. Many within the British government suggested Britain go off the gold standard until unemployment was under control and the currency stabilized, but Norman stubbornly refused and set the wheels in motion for years of economic disaster in Britain, laying the groundwork for the country to be hit hard by the Great Depression.

Following the war, the country that had accumulated the most debt was undoubtedly Germany. Not only did Germany inflate its currency by four times its pre-war value, they were also forced to pay $12.5 billion in reparations, which at the time was roughly 5 percent of its GDP (1719). The reparations were supposed to be a punitive punishment for Germany engaging in the war, but many believed it was simply France trying to protect itself from another invasion by weakening its neighbor’s economy.

Hjalmar Schacht was the head of the Reichsbank following the war. After only two weeks in office, Schacht had a plan to pull Germany out of debt. He met with British banker Montagu Norman and proposed that Norman lend Germany $25 million to set up its sterling reserves. He also planned to raise an additional $25 million from capital held in German banks in order to gain access to the London market, which would provide access to loans up to $200 million (Ahamed 2849). After the country inflated its currency exponentially during the war, the result was a currency collapse after they were forced to pay war reparations.

However, Schacht was able to convince Norman to lend the money under one condition: Germany base its bank on the pound sterling (Ahamed 2862). Germany would then issue loans and bank notes in pounds, which would in turn strengthen the British pound – a goal Norman had been hoping to accomplish for years, because at the time nearly all banks held reserves in gold instead of sterling. By accumulating more debt in a country that had already destroyed its currency, Schacht was setting up Germany for further economic disaster.

Eventually, Germany had accumulated enough loans from the United States that they believed the U.S. would help persuade the rest of Europe to reduce reparation payments, allowing the country to once again become economically successful. Schacht believed he could talk the foreign governments into reducing the payments to under $200 million per year (Ahamed 4847). The plan failed miserably and Germany was not only stuck with billions of dollars in reparations they could not pay, but Schacht had also tried to negotiate the return of previous German colonies in an attempt to overturn provisions of the Treaty of Versailles. This frosted relations between European powers, as Germany was upset that fellow European countries were unfairly collecting billions of dollars in German debt, while the other European powers were upset that Germany was not abiding by the terms of the treaty that was signed following the war.

The only country that had managed to profit from the war was the United States. Not only was the war a success economically, but the United States was also owed millions in war debt due to their financing of other European countries during the conflict. Coupled with the fact that no fighting had taken place on U.S. soil, meaning they did not have to pay to repair infrastructure, the United States made out well following World War I. During the war, a banker by the name of Benjamin Strong had been appointed as the first governor of the Federal Reserve Bank of New York.

As head of the Federal Reserve, Strong worked to keep interest rates low by stabilizing prices, which resulted in the economy expanding thanks to the automobile industry (Ahamed 4000). Strong worked to keep European debts at a minimum by issuing artificially low credit, which gave rise to a speculative culture, where anyone could become rich in a matter of moments via the stock market due to the accessibility of loans and credit. Strong himself had voiced concern to Montagu Norman about the high rise in stock prices, as it could eventually lead to a crash and a run on United States banks, which ultimately happened near the beginning of the Great Depression. There was a massive bubble during Strong’s time as governor of the Federal Reserve, as profits were not keeping up with the high stock prices, and the bubble was about to burst, caused in part by Strong’s actions.

The last member of the quartet of central bankers that would shape the world’s economic policies following World War I was Emile Moreau, head of the Banque de France. The central bank of France had lost a great deal of credibility following the war after it was revealed that the French Treasury had deceived the public and cooked the books (Ahamed 3561). As a result, it became harder for the country to acquire loans, as many countries felt they could not trust the French to repay the loans. One of Moreau’s main achievements was stabilizing the franc. Although never a traditional banking power, France had a surplus following the war, with a massive flow of money coming in that increased the value of the franc.

When the franc eventually reached 30 to the dollar, many were worried that the French were about to make the same mistake the British had made, which was implementing an exchange rate that was too high. This could, in turn, cause the price of exports to rise and become uncompetitive in the international market. Whereas other countries chose to either pass off the debt to its taxpayers, or impose inflationary techniques to eliminate the expenses, Moreau employed a moderate approach when dealing with the franc’s rapid ascension in value.

Moreau, with the assistance of French Prime Minister Poincare, began purchasing foreign exchange and selling the country’s currency in order to prevent it from rising above 25 to the dollar (Ahamed 3954). His policy of intervention helped stabilize the currency price and France accumulated a reserve of $500 million dollars, with most of it being in pounds (Ahamed 3963). He made a critical mistake, however, in underestimating the importance of the exchange rate (Ahamed 3971). His oversight led to Moreau undervaluing his currency while attaching it to the gold standard.

The decisions of the four central bankers essentially locked the four countries together economically following the war. Germany had invested heavily in the sterling pound in order to obtain post-war loans and the Germans also obtained massive loans from the United States. France had invested in various currencies and undervalued its own currency in the process, meaning if those currencies collapsed, the franc would also take a hit. Britain had issued Germany loans when they had already defaulted on their reparation payments, while also owing the United States millions of dollars for war expenses. The United States, the most profitable economic power at the time, was the common bond between all four countries, as they were owed money from the other three countries and were at the same time helping Germany recover.

It is no surprise then that when the United States economy collapsed after decades of speculation, the other countries suffered as well. America quickly began to disinvest in Europe after they were hit hard at home, and eventually enacted the Smoot-Hawley Act, a legislative measure that raised tariffs in an attempt to promote American products. France, through Moreau’s tactic of keeping the franc at a low rate, kept French goods competitively priced and France became the primary economic power in Europe. France and the United States eventually held 60 percent of the world’s gold (Ahamed 5596), which was highly disruptive to the world economy at a time when currencies were tied to the gold standard. In all, the decisions of the four central bankers to rely upon one another, peg their currency to gold, and incur debt in a time when their economies were still recovering accelerated the effects of the Great Depression.

Throughout the novel, Ahamed discusses his economic views. In stating that the Great Depression was not just a single crisis but a series of crises, Ahamed outlines how one single catastrophe can, in his words, ricochet to other parts of the world if countries become too reliant upon one another (Ahamed 7392). He also advocates intervention in times of crisis. During the Great Depression, the United States chose to cut back its investments in Germany when they were unable to pay off debt due to rising interest rates and the fact that the country took on too much short-term debt. He parallels it to the situation in Mexico in 1994. During that crisis, Mexico also took on too much short-term debt and had trouble paying it back after interest rates rose significantly. Instead of ignoring the situation, the United States issued a $50 billion emergency credit, which in turn lessened the blow and averted a situation that could have been much worse.

Ahamed also believes tying a currency to the gold standard is foolish, as it is impossible to devalue the currency if necessary. Also discussing the situation in Mexico, Ahamed claims Mexico had the ability to devalue the peso, but Germany had no such option because their currency was bound by the gold standard. Lastly, Ahamed believes in federal intervention during a banking crisis. Instead of sitting idly like the Federal Reserve did during the 1931-33 crisis where they allowed numerous banks to fail, he believes the federal government should inject liquidity into banks so as not to prevent banks from issuing credit (Ahamed 7423).

Ahamed’s economic views are very similar to those of Paul Krugman. Much like Ahamed, Krugman also believes in floating currencies and does not advocate having a currency tied to a particular standard (Krugman, 74). He also believes that regulation is necessary to prevent financial markets from collapsing, and intervention is a necessary step in certain instances. Lastly, both Krugman and Ahamed believe it necessary to allow countries to devalue their currency if necessary. Krugman states it is important to “seek low but not too low inflation rather than price stability (Krugman, 74).

Ultimately, it is hard to argue with the economic philosophies of either Ahamed or Krugman. It is foolish to tie a currency to the gold standard, as there is only a certain amount of gold in the world. Therefore, when it becomes concentrated in the hands of a few, such as what happened with France and the United States, it hurts other currencies across the globe. Regulation and intervention are also necessary to stabilize an economy during troubled times. It is better for the government to issue a loan to a failing bank than to let it fail and have credit restricted, which in turn can hurt businesses. Lastly, countries must work to keep inflation rates low to prevent the value of the currency from fluctuating rapidly.

The lessons learned during the Great Depression are still prevalent today, as Ahamed states. Having finally just recovered from a massive financial crisis, the United States economy is still not as strong as it was just a few years ago. However, it is hard to imagine how much worse the situation could have been had the government not intervened and injected liquidity into the failing banks. Likewise, without government regulation, programs like the FDIC would not exist. Without federal programs, consumers would be left with no guarantee that their assets are insured and protected in the event of a banking crisis. It is also important for the world’s economic powers to cooperate but not become too reliant upon one another. Ahamed shows that protectionist policies such as the Smoot-Hawley Act only hurt the world economy, and massive economic burdens such as those levied at the Paris Peace Conference can have an effect on all countries, not just those expected to pay the punitive damages (7449).

In conclusion, as Ahamed states, the Great Depression was not an economic catastrophe that was the result of an act of God (Ahamed 7445). Instead, it was a direct result of poor decisions made by politicians and bankers. Politicians were to blame for the war debts and engaging in protectionism to insulate their respective countries. Bankers were to blame for making poor economic decisions in the wake of World War I – most notably taking the world back onto the gold standard. Their ideas worked for a short time, but eventually proved to be unsustainable and the world economy collapsed. Therefore, it is important to study the decisions made following World War I to ensure the same mistakes are not made again in the future, because economic collapse is not some distant fantasy that could only happen in the 1920’s and 30’s, but is instead a harsh reality that can happen at any time under the right circumstances. 

Works Cited

Ahamed, Liaquat. Lords of Finance: 1929, The Great Depression, and the Bankers Who Broke the World. New York: Penguin, 2009. Kindle file.

Krugman, Paul. “The Return of Depression Economics.” Foreign Affairs, vol. 78 no. 1, 1999, pp. 56-74. JSTOR. Web. http://www.jstor.org/stable/20020239