The great liquidity crisis - 94 years ago

When the history of the current financial crisis comes to be written, the battle of the index entries will surely be won by central bankers not politicians. The name Bernanke will appear on many more pages than Bush, King more often than Brown, and Trichet will trump even Sarkozy. Most of the time, central banks strive to be dull places; the people who run them relish their obscurity. But when crisis strikes, the limelight shines.

The last great liquidity crisis to hit the global financial system happened 94 years ago, at the end of July 1914. It paralysed the wholesale money market, closed the world’s stock markets for months and necessitated unprecedented government intervention in the banking system. Rightly, this is where Liaquat Ahamed begins.

A semi-retired investment manager, Ahamed set out to tell the story of the four dominant central bankers of the inter-war period. He cannot have foreseen how timely his book would be. Unlike most works on the origins of the Great Depression, Lords of Finance is highly readable – enlivened by vivid biographical detail but soundly based on the literature. That it should appear now, as history threatens to repeat itself, compounds its appeal.

Ahamed’s four central characters are ?mile Moreau, governor of the Banque de France; Montagu Norman, governor of the Bank of England; Hjalmar Schacht, president of the German Reichsbank; and Benjamin Strong, governor of the Federal Reserve Bank of New York. By 1926 they constituted “the most exclusive club in the world” but in 1914 they were largely unheard of.

Norman was a partner at the British affiliate of US merchant bank Brown Brothers. Neurotic and prone to bouts of mental collapse, he lived in a large, gloomy house off Holland Park, surrounded by furnishings of his own design, listening to Brahms and dabbling in spiritualism. With his long ginger beard, he looked more like a boulevardier than a banker.

At the other extreme was Schacht, a Hamburger who affected the stiff gait of a Prussian reserve officer, complete with bristling moustache, high celluloid collar and fierce glare. In 1914 he was rising through the ranks of Dresdner Bank.

Of the four, Benjamin Strong was the furthest advanced: president of the powerful Bankers Trust Company, an offshoot of the financial empire of JPMorgan. His troubles were purely personal: a first wife who committed suicide and the onset of the tuberculosis that ultimately killed him. Moreau, meanwhile, was a happy, healthy civil servant whose career had taken a wrong turning. Having served as chef de cabinet to the scandal-prone finance minister Maurice Rouvier, Moreau was sidelined at the Algerian central bank.
The war and its traumatic aftermath transformed all their careers. An architect of the Federal Reserve System, Strong accepted the governorship of the New York Fed in 1914. Norman joined the Bank of England in 1915 and became governor five years later.

Schacht had a less good war but re-launched his career in 1923, when hyperinflation had rendered the German currency worthless: having successfully introduced the new Rentenmark currency, he was appointed Reichsbank president before the year was out. Two and a half years later, political crisis propelled Moreau into the top job at the Banque de France.

The task facing these four men wasn’t small. After the first world war, victors and losers alike were saddled with immense foreign debts; all the European currencies had depreciated to varying degrees. The myriad new trade barriers made it ever harder for debtors to earn hard currency from exports.

Outwardly, as Ahamed shows, the central bankers seemed to co-operate. Their frequent peregrinations across the Channel and the Atlantic attracted febrile press speculation. (So over-attentive were the reporters that Norman even took to sailing under an assumed name, “Professor Clarence Skinner”.) Friendship flourished between them; “Dear Strong” and “Dear Norman” became “Dear Ben” and “Dear Monty”; Norman made a point of cultivating Schacht. The exception was Moreau, whom Norman couldn’t resist insulting and who declined when Strong invited them all to New York in 1927, a year before his untimely death.

Yet for all their communication, the four failed to reach an optimal resolution of the world’s financial problems. Strong encouraged Norman’s quasi-religious faith in the restoration of the gold standard, and helped finance the British return to the prewar dollar exchange rate. Yet Strong never allowed the gold standard to work as it was supposed to, systematically counteracting (“sterilising”) the effect of gold inflows on the American money supply. Meanwhile, Moreau intervened against the franc so the French currency was undervalued, ensuring export surpluses and the rapid growth of the Banque de France’s reserves. Schacht, on the other hand, obsessed about flows of hot money into Germany and the continuing burden of reparations on the German balance of payments.

The result was that what we would now call “global imbalances” were not reduced, even when economic conditions were relatively good. When Wall Street bubbled and then burst in 1928 and 1929, the Europeans wholly underestimated their own vulnerability. Norman saw the Wall Street crash as a boon for sterling, claiming the “credit” for having caused the New York sell-off by raising British interest rates the previous month.

By the summer of 1931, however, it was dawning even on Norman that the world economy was falling off a cliff. With massive bank failures on both sides of the Atlantic, it became clear that the Lords of Finance had bungled things. “Unless drastic measures are taken to save it,” he wrote to Moreau’s successor at the Banque de France, “the capitalist system throughout the civilised world will be wrecked within a year.” (With a characteristic flourish, he went on: “I should like this prediction to be filed for future reference.”)
Such apocalyptic fears were not new. As early as November 1918 Strong had warned Norman of a coming “period of economic barbarism which will menace our prosperity”. The irony was that their favoured prophylactics had, in combination, made the apocalypse more likely. By 1931 the capitalist system was on its knees, and democracy with it. Schacht was soon flirting with the rising star of the German right, Adolf Hitler; he later served as his economics minister.

As the world teeters on the brink of another great financial cliff, we can only hope that the modern-day Lords of Finance will co-operate to better effect. I suspect none has much time for bedtime reading these days. But should Messrs Bernanke, King and Trichet need a reminder of what can go wrong when central bankers achieve only the semblance, but not the reality, of co-operation, Lords of Finance is the book they should read.

As a matter of urgency, a Chinese translation should also be sent to Zhou Xiaochuan, governor of the People’s Bank of China.

Niall Ferguson is a contributing editor of the FT and author of ‘The Ascent of Money: A Financial History of the World’ (Allen Lane)

Copyright The Financial Times Limited 2009

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