Lords of Finance

1. Central bankers shaped the global economy in the 1920s

For the world's most important central banker to have a nervous breakdown as the global economy sank yet deeper into the second year of an unprecedented depression was truly unfortunate.

The power of central bankers. In the 1920s, a small group of central bankers wielded enormous influence over the global economy. Key figures included:

• Montagu Norman of the Bank of England
• Benjamin Strong of the Federal Reserve Bank of New York
• Hjalmar Schacht of the Reichsbank
• Émile Moreau of the Banque de France

These men made crucial decisions about interest rates, currency values, and international loans that shaped the economic landscape. Their personal relationships, rivalries, and ideologies often influenced policy choices with far-reaching consequences.

Challenges faced. The central bankers grappled with:

• Rebuilding the international financial system after World War I
• Managing the return to the gold standard
• Dealing with war debts and reparations
• Responding to economic crises and market speculation

2. The gold standard's return created economic imbalances

"I will make you the golden Chancellor."

The gold standard dilemma. The return to the gold standard in the 1920s was seen as crucial for economic stability, but it created significant problems:

• Britain rejoined at an overvalued rate, making its exports uncompetitive
• France set its franc at an undervalued rate, giving it an unfair advantage
• The United States accumulated excessive gold reserves, creating global imbalances

These disparities led to deflationary pressures in some countries and contributed to economic instability. The rigid rules of the gold standard limited countries' ability to respond to economic challenges, ultimately exacerbating the Great Depression.

Attempts at management. Central bankers tried to manage these imbalances through:

• Interest rate adjustments
• International loans
• Currency interventions
• Informal cooperation agreements

3. Reparations and war debts strained international relations

"Les Boches paieront" "The Krauts will pay"—was the refrain.

The burden of war debts. The aftermath of World War I left a complex web of debts and reparations that strained international relations:

• Germany owed massive reparations to the Allies
• European Allies owed war debts to the United States
• The U.S. insisted on repayment while Europeans sought debt forgiveness

This situation created resentment and economic instability, particularly in Germany. The Dawes Plan of 1924 attempted to address the issue by restructuring German reparations, but it ultimately failed to solve the underlying problems.

Consequences:

• Fueled economic nationalism
• Contributed to political instability in Germany
• Hindered economic recovery in Europe
• Strained diplomatic relations between allies

4. Monetary policies fueled speculation and market instability

Strong had very deliberately not invited any members of the Federal Reserve Board to the Mills house.

The Fed's fateful decision. In 1927, Benjamin Strong of the New York Fed orchestrated a decision to lower U.S. interest rates to help Britain maintain the gold standard. This decision had unintended consequences:

• Fueled speculation in the U.S. stock market
• Contributed to the formation of a market bubble
• Created tensions within the Federal Reserve System

The policy highlighted the challenges of balancing domestic and international economic concerns, as well as the dangers of opaque decision-making in central banking.

Consequences of easy money:

• Rapid rise in stock prices
• Increase in margin lending
• Growing concerns about market stability
• Criticism of the Fed's focus on international issues

5. Personal rivalries influenced global financial decisions

Norman dominated the proceedings, seated at one end of the conference room in a fan-backed oriental chair.

The impact of relationships. The personal dynamics between central bankers significantly influenced policy decisions:

• Norman and Strong's close friendship shaped Anglo-American cooperation
• Norman's rivalry with Moreau hindered Franco-British coordination
• Schacht's confrontational style created tensions with other bankers and politicians

These relationships often superseded formal institutional structures, leading to both productive collaborations and damaging conflicts.

Key relationships:

• Norman-Strong: Close allies
• Norman-Moreau: Antagonistic
• Schacht-Norman: Initially cooperative, later strained
• Strong-Moreau: Increasingly sympathetic

6. The U.S. stock market boom led to the Great Depression

In August, following the Fed cut in rates, the market immediately took off.

The buildup to the crash. The U.S. stock market experienced a dramatic boom in the late 1920s, fueled by:

• Easy credit policies
• Technological optimism
• Widespread speculation

The Federal Reserve's attempts to curb speculation through interest rate hikes in 1928-29 came too late and were too aggressive, contributing to the market crash and subsequent economic contraction.

Key factors in the boom:

• Low interest rates
• Margin lending
• New industries (e.g., automobiles, radio)
• "New era" thinking
• Limited regulation of financial markets

7. Central bank independence was crucial yet challenged

Though the governor and deputy governors by this time tended to be drawn from the ranks of the higher civil service, they were still ultimately responsible to the twelve-man Council of Regents.

The importance of independence. Central bank independence was seen as crucial for maintaining monetary stability, but it was often challenged:

• Political pressures to finance government deficits
• Conflicts between national and international economic objectives
• Disagreements within central banks about policy direction

The structure and governance of central banks varied, influencing their ability to resist external pressures and make independent decisions.

Challenges to independence:

• Government interference
• Public criticism
• Internal disagreements
• Conflicting mandates (e.g., domestic vs. international stability)

8. Economic nationalism hindered international cooperation

I explained to the Prime Minister that since England was the first European country to recover a stable and reliable currency after the war, it had used this advantage to build the foundation for a veritable financial domination of Europe.

The rise of economic nationalism. Despite attempts at international cooperation, economic nationalism increasingly shaped policy decisions:

• Countries prioritized domestic economic interests over global stability
• Competitive devaluations and protectionist measures became common
• Efforts to maintain national prestige influenced monetary policy

This trend undermined the fragile international financial system and contributed to the severity of the Great Depression.

Manifestations of economic nationalism:

• Currency manipulation
• Trade barriers
• Competition for financial influence in smaller countries
• Reluctance to coordinate policies internationally

9. Hyperinflation in Germany had lasting consequences

By November 1923, Germany experienced the single greatest destruction of monetary value in human history.

The trauma of hyperinflation. The hyperinflation in Germany in 1923 had profound and lasting effects:

• Destroyed savings and upended the social order
• Created deep distrust of paper money and government financial management
• Influenced German economic policy for decades
• Contributed to political instability and the rise of extremism

The experience shaped German attitudes towards monetary policy and influenced the country's approach to European economic integration in later decades.

Consequences of hyperinflation:

• Wiped out middle-class savings
• Undermined faith in democratic institutions
• Created a strong aversion to inflation in German culture
• Influenced the Bundesbank's later focus on price stability

Last updated: September 20, 2024