Book Review - Lords of Finance

In the middle of recession there are invariably questions about how we got into it and what we can do to get out of it. Politically, it quickly devolves into a conflict between the market driven laissez-faire economists and the interventionist Keynesian ones. Television and radio infotainers yammer on using their own peculiar jargon leaving the rest of us, who are not economists, as much in the dark as we were before.

I wanted to know more, so I picked up Liaquat Ahamed’s detailed history of how the world stumbled into the Great Depression, “Lords of Finance.”

When my wife, a fellow artist, glanced at the title, she gagged, “Aawch! Arrgh! P’tooey! What kind of man did I marry?”

“Easy, love,” I cajoled, It’s history; it’s biography. It’s about people, not the principles of economics.”

She felt better. But her reaction is one that may unfortunately be repeated across the country by those who either do not understand the intricacies of Central Banking, like me, or are highly suspicious of it like many of my friends who think of it as a vast conspiracy of international bankers, or who, like my wife, just find the whole subject distasteful, the province of tightly buttoned men in bowler hats and stiff collars. But, by-passing this book for any such reason would be a mistake.

Ahamed is a twenty year veteran of investment banking and some paragraphs have to be read over a few times, but generally it’s written for the layman. It comes in at 508 pages, without notes, but it reads like a well crafted novel.

The main characters, the “Lords” themselves, are Montague Norman of the Bank of England, Hjalmar Schacht of the Reischsbank in Germany, the American Benjamin Strong of the New York Federal Reserve, and Emile Moreau of the Banque de France. all of whom were well intentioned but ultimately flawed men who were not immune from the kind of gross miscalculations and unwarranted fears that led to the financial disaster of the Great Depression. While a great deal of information may be gleaned from their stories that is applicable to the present one must be cautious; 2010 is not 1929. As an old history professor of mine once said, “There are no historical patterns.” Yet there are some lessons that may be learned.

Some of the miscalculations early twentieth century central bankers made were over the conduct and financing of World War I. No one in financial circles believed the war would outlast the various governments’ ability to pay for it. They were all on the Gold Standard, you see, and the financial resources of each country were tied to their reserves of gold. It was hard to imagine Germany, France and Britain would be so foolish as to burden their countries with massive debt just to keep a war going.

These top-hatted and stiff-collared expert prognosticators, mired as they were in centuries-old financial traditions based on the availability of precious metals, completely overlooked the proclivity of wars (particularly wars between monarchies, empires and single-party republics) to be self-sustaining and self-fulfilling. If wartime governments run out of money, they borrow it, mostly from foreign banks incurring massive debt. If they don’t have enough currency, they print it, all to keep the war going toward ultimate victory, at which time all debts will be easily repaid. Or so they thought.

No lessons there that can be applied to today, right?

As a side note, I have often maintained that America should never have gotten into WWI, which was, if anything, a family spat among the various progeny of England’s Queen Victoria. The Royal Houses of Europe were doomed whatever the outcome of the war and for America to step in and help preserve one of them against the incursions of another, much less finance it, was a huge mistake. Nothing in this book has dissuaded me from that opinion; World War I caused most of the problems leading to WWII which is most accurately described as “Act II.” of the same tragedy.

The incipient catastrophes from financing the First World War in so unsustainable a fashion were exacerbated by the enmeshment of world financial interests. In the introduction, Ahmed explains, “Because financial institutions were so interconnected, borrowing large amounts of money from one another even in the nineteenth century, difficulties in one area would transmit themselves throughout the entire system.”

Ahamed stops way short, however, of ascribing this financial enmeshment to any conspiracy of central banking institutions. In retrospect it may read like a Dan Brown novel, but conspiracies require agreement, and the central bankers in the 1920’s could agree on almost nothing. Scrambling to force some post-war order on the economies of their respective countries, they formed alliances, made enemies, forced concessions, engaged in blackmail and all manner of intrigues eventually stumbled backwards into Great Depression through incompetence, a too rigid loyalty to ideological principles, and misguided policy.

The biggest blunder, on the road to the Great Depression was the N.Y. Fed’s decision to lower interest rates. It may have helped Germany’s cash-flow, but it caused massive speculation on Wall Street as investors borrowed more and more money to purchase stocks, further inflating the bubble that burst on October 29, 1929, “Black Tuesday.”

Ahamed writes, “Their goal is a strong economy and stable prices. This is, however, the very environment that breeds the sort of over-optimism and speculation that eventually ends up destabilizing the economy. In the United States during the second half of the 1920s, the destabilizing force was to be the stock market.” (p.280)

We are put in mind of the economic situation in America before the current recession: Overspeculation, easy credit, artificially inflated prices, and a protracted military campaign resulting in massive “bad debt,”* much of which is held by foreign banks, principally China.

In the Depression, as well as today, the main conflict on the road to recovery was,
“Between those who believed that governments could be trusted with discretionary power to manage the economy and those who insisted that government was fallible and therefore had to be circumscribed with strict rules.” (p.230)

Traditionalists said Government should keep its hands off the economy and allow the “invisible hand” of the market to determine its course as proposed by eighteenth century economist Adam Smith. Others, principally twentieth century economist ,Maynard Keynes seen in the photo on the right, said the government must have control over the economy to keep market pressure from destabilizing it. His “A Tract on Monetary Reform” revolutionized economic policy and is still highly influential today.

“The real issue for the [Federal Reserve] governors was that many of the banks closing their doors…had sustained such large losses on their loans that they were … insolvent, [the governors] made it a principle to let them go under. They failed to recognize that by doing so they were undermining public confidence in banks as a repository of savings and were causing the U.S. credit system to freeze up.” (p. 391)

It is somewhat telling that President Franklin Roosevelt did not listen much to the same economic theorists who got the country into the mess he inherited from Hoover. After considering their opinions, he trusted his own instincts, injecting huge amounts of federal money into programs to create jobs and capitalize businesses, what he called “priming the pump.” This in spite of conservative objections that he was bankrupting the country.

What government aid did come, however, was too late. By that time, Ahamed writes “Banks, shaken by the previous two years, instead of lending out the money, used the capital so injected to build up their own reserves.” (p.439)

Ahamed seems to say that when a crisis looms, the injection of funds to shore up failing banks should come sooner rather than later and in sufficient quantity to capitalize the banks and allow them to begin lending. When Adam Smith’s “invisible hand” goes arthritic, Maynard Keynes is there to take over the heavy lifting.

Amid the chorus of our own contemporary “know-nothings” who spout partisan absurdities about the government not getting involved in economic policy, or how deficit spending to get the economy out of crises is tantamount to cultural Armageddon, Ahamed’s analysis is a voice of reason. “The Great Depression was caused by a failure of intellectual will, a lack of understanding about how the economy operated. No one struggled harder … than Maynard Keynes. He believed that … economists are the “trustees, not of civilization but of the possibility of civilization.” (p. 504)

That’s something even an artist like me can understand.

*Bad debt is, according to Robert Kiyosaki, debt that does not provide for a return on the investment.