BOOK REVIEW: Liaquat Ahamed's Lords of Finance
Long before Ben Bernanke, Henry Paulson and Tim Geithner were empowered to allegedly save the world's financial system from collapse, a collection of four central bankers from the United States, England, Germany and France similarly controlled the globe's financial fate in the years between the two major wars of the twentieth century. Investor Liaquat Ahamed tells their story in endlessly interesting fashion in his book Lords of Finance, which chronicles the monetary decisions made in the 1920s that proved impactful in the 1930s and beyond.
New York Fed President Benjamin Strong, Bank of England Chairman Montagu Norman, Banque de France head Emile Moreau and Reichsbank Chairman Hjalmar Schacht were the chief architects of the world's return to monetary normalcy after the death and destruction of World War I. And while some - particularly libertarians - will find fault with some of Ahamed's analysis, his history of the period is an exciting read regardless of one's policy leanings.
The major monetary issue in the aftermath of World War I concerned how the world's central banks would return to the gold standard. This was easier said than done because with England, France, Germany and the U.S. having left gold during the war (conflicts have historically been financed with debased money), there was much debate over which currency prices should be used upon a return to the standard.
One thing that wasn't up for discussion was whether or not a resumption of the gold standard was a good idea. Ahamed referenced author H.G. Wells's observation that gold had "a magnificent stupid honesty" about it, so it wasn't a question of if countries would return to the stability offered by gold; rather it was a question of which gold parities should be used. For those - including this writer - who regularly call for currency-price stability as a cure for much of what ails us, the serious commitment among the central bankers of the past to stable money will read in a very appealing way.
Once the war ended it was pretty simple for the U.S. to return to gold at the $20.67 parity given that so much of the yellow metal had reached our shores during the conflict. For England, France and Germany the answer wasn't as easy due to reduced gold stocks in each country, along with inflation. According to Ahamed, money in circulation (not always a good measure of the money price) had doubled in England, tripled in France, and quadrupled in Germany in the war years.
Post-Armistice, the British pound could no longer command $4.86, the French franc fell from 5/USD to 50, and the German Mark fell from roughly 4/dollar all the way to 4.2 trillion. So while it seems Ahamed overrates the inability of producers in "strong" currency countries to export (Japanese exports to the U.S. have skyrocketed over the last 39 years despite the yen's stupendous rise against the dollar), the price at which currencies would return to gold was no easy decision. The debtor/creditor relationship lies at the heart of monetary decisions (or, at least it should), and with the European economies having adjusted somewhat to wartime inflation, a return to pre-war parities promised to retard this relationship. Ultimately England felt that its continuance as the World's Banker would be a function of returning to pre-war parities, Germany eventually replaced the Mark with the rentenmark (Marks had mostly disappeared amid hyperinflation), while France perhaps smartly re-pegged the franc at 25/1.
The story of France is in many ways the most interesting when it comes to the return to currency stability. Ahamed masterfully describes Moreau's rise from the political wilderness to a position of great importance as the head of the Banque de France, but even more intriguing was the impact (before France's return to gold) Prime Minister Raymond Poincare had on the franc's health. Ahamed observes that within a week of his arrival in office, the franc rose from 50 to the dollar to 35, before eventually settling at 25/USD. Here lies a lesson for modern commentators who presume political changes don't impact currency values, that only "money supply" matters. Just as the franc rose with Poincare's ascendance, so did the dollar strengthen in 1980 as polls revealed the growing likelihood that strong-dollar advocate Ronald Reagan would be elected President of the United States.
Modern history - even that of the "supply side" variety - says that France's decision to essentially devalue the franc at the 25/USD parity was a good one; a decision the Bank of England's Norman (and Chancellor the Exchequer Winston Churchill) perhaps wished he'd made. But it's not perfectly clear from Ahamed's account if the latter is true. Indeed, while Ahamed recounted that France's economy roared back with the cheaper franc at one point in the book, thirty pages later he noted that the economic situation there in the mid-20s "was grave."
Regarding the U.S., Ahamed writes that despite massive gold inflows stateside - inflows which presumably resulted from increased U.S. productivity - the New York Fed's Strong "began to short-circuit the effects of additional gold on the money supply by contracting the amount of credit that it supplied to banks, thus offsetting any liquidity from gold inflows." This is important because contrary to the widely held belief among Monetarist and Austrian school thinkers who've taken to describing the 1920s as an inflationary period, all evidence points to the Fed failing to liquefy economic activity at a time when a growing economy perhaps demanded it.
Government price indices are notoriously inaccurate, but it's notable in considering the above what Ahamed found; that "Since 1925, U.S. wholesale prices had fallen 10 percent, and consumer prices 2 percent." It's widely believed that the 20s were inflationary and the 30s deflationary, but the dollar was devalued in the 30s, and as for the ‘20s, would economy-retarding legislation of the Smoot-Hawley sort have ever seen the light of day absent a monetary deflation? Ahamed's book raises many important questions, but this might be the most important one.
As for England, once back on the gold standard, much of Ahamed's account concerns its ultimately failed struggle to remain so. Interest rate machinations in the U.S. and France, along with the aforementioned unwillingness of monetary authorities in the U.S. to liquefy economic activity are cited as major factors in the U.K.'s inability to take in enough gold to remain on the standard, but it seems there Ahamed left out the certain role of taxation when it came to Britain's economic struggles.
Indeed, one perhaps unsung factor in the post-war gold influx to the U.S. was a return to normalcy in terms of taxes that brought the top rate down to 25%. Production is money demand, and with Americans producing a lot, gold inflows even after the war shouldn't surprise us. Regarding England, Ahamed's account didn't mention how wartime tax rates there remained in place even after the war ended. So while it may be true that England erred somewhat in not devaluing in the war's aftermath, a certain factor concerning its inability to lure gold its way had to do with nosebleed tax rates that reduced incentives on the part of the British to produce.
Turning to Germany, the Reichsbank's Schact eventually got the German currency back on sound, gold footing, but Ahamed fingers excessive reparations payments as a large factor in the country's eventual destabilization. No doubt the bills loomed large, but it's possible Ahamed underrated heavy borrowing on the part of the German government to fund all manner of spending unrelated to war debts which crowded out true productivity.
Ahamed does note that later on in the ‘20s, private investors were no longer at the front of the line during debt-payment shortfalls, so as he put it, it wasn't surprising "that foreign landing to Germany collapsed." As it turns out, Germany ultimately paid back a pretty small fraction of its WWI debts, which raises the question of how Germany's economy would have performed absent what Ahamed termed "high on the hog" government spending during the good times. Had the government been more humble in its borrowing and spending, it's fair to suggest that its economy wouldn't have imploded as much as it did, thus possibly making Adolf Hitler an historical footnote.
This is a gross simplification of an important book, but Ahamed generally concludes that the fashion in which the world's major economic powers - led by Strong, Norman, Moreau and Schact - returned to gold wrote the story of their undoing. With gold flows - in particular those from the United States - not substantial enough for countries like England to maintain the standard, it eventually had to leave gold altogether.
Worse, due to constant sniping from Herbert Hoover and others about the continued rise of the U.S. stock market (Ahamed memorably recounted that the Dow fell 7% the week Hoover became the GOP nominee for president), the Fed began to raise rates (by this time Benjamin Strong was dead) to make U.S. shares less attractive, but which perhaps exacerbated the gold supply problem as rising U.S. rates forced increases (shades of Greenspan and "irrational exuberance" seventy years on) worldwide. Market collapses ensued, though not nearly in the way that stocks fell in the U.S. which, will in itself cause many a reader to ponder what happened stateside that led to a much more brutal crash. Ahamed would disagree, but it says here Smoot-Hawley's looming passage was the match that lit the economic fire, followed by economy-retarding tax increases and general government intervention/spending that turned what should have been a minor downturn into a depression.
Beyond Ahamed's exciting retelling of the economic period just described and the men who loomed large within that time, there's quite a lot of facts and figures that the economically inclined will enjoy. About the World War I years, he notes that despite increased production stateside to support the allies that this didn't boost stock prices owing to the greater truth that "few investors were convinced that European Armageddon could be good for stocks in the long run."
As for the popular notion today that wars themselves are stimulative, Ahamed crucially points out that once the U.S. was in the war, the effort itself "consumed great chunks of the national product, and profits suffered." Hopefully this piece of information combined with stock return data mentioned above puts to bed the positively horrifying notion so widely held today that wars are the path to economic health.
Regarding the other widely held belief that money itself is economic growth - as opposed to merely a measuring rod that facilitates exchange and investment - Ahamed found that once FDR imposed a bank holiday in 1933, "Americans adapted to life without banks remarkably well" as barter, IOUs and scrip replaced traditional money. As the author put it, the period just described was "a reflection of how adaptable and elastic the notion of money can be."
Many of us remember how 7 to 10 stocks accounted for much of the rise of the S&P 500 in the late ‘90s, with a great deal more either treading water or declining during those boom years. Much the same occurred during the 1920s according to Ahamed, with the rise of "new economy" companies such as GM and RCA whitewashing struggles within firms that represented the "old economy". Indeed, during the roaring bull market of the '20s, for every NYSE listened company that rose in value, one declined.
And for those who see central banks as the problem, rather than the solution, Ahamed, while disagreeing, acknowledges that the "United States survived and even prospered without a central bank" for "seventy-plus years." With money insignificant except for serving once again as a measuring stick, one can only wonder how much different the last hundred years might have been without an interventionist Fed.
Of course there were some disagreements too. Throughout the author talked up cheap currencies in countries such as France as the path to a successful export strategy. Well, not only can we not export without importing goods of the same amount, it seems Ahamed ignored here how the cost of goods produced rises amid devaluation alongside capital to some degree going on strike.
Ahamed also discounts the impact of the Smoot-Hawley tariffs on the 1929 crash and subsequent economic weakness as minor relative to problems with capital flows. He argues that tariffs drive up internal demand for domestic goods which by his lights means Smooth-Hawley would have had "an expansionary effect." If we accept his view that cross-border trade wasn't as prevalent then, this doesn't reduce the massively negative economic impact of work specialization moving in the reverse. Tariffs merely subsidize the weak at the expense of the strong, something he no doubt knows, but that his analysis ignored.
More than that, assuming a closed U.S. economy, rising internal demand would certainly be an economic negative for rising prices reducing the range of goods available to us. We produce in order to consume, but tariffs would raise prices for limited U.S. goods all the while strangling nascent U.S. industries in the cradle. Lastly, stocks are best for pricing in the future, and a future of closed economic borders would necessarily chill the markets for the aforementioned loss of specialization and weak-company subsidization, not to mention the strong historical correlation between closed lines of trade and war.
Ahamed is well convinced that "Breaking with the dead hand of the gold standard was the key to economic revival", but looking at the ‘30s and the eventual rush to war, where was the revival? Sure enough, our return to gold in the aftermath of World War II played a major role in the resumption of global growth thanks to greater currency certainty and reduced trade barriers. In that sense was gold the problem in the ‘30s, or was it tax and trade mistakes, massive government intervention in the economy, and merely a return to gold in the wrong way that caused so much economic pain?
Most of all, John Maynard Keynes emerges heroic in the book's conclusion, but the simple truth is that his influence on FDR was already apparent in the early 1930s, with no positive impact. Indeed, as Ahamed himself made plain earlier in Lords of Finance, "the U.S. economy had faced a similarly sharp decline in prices and production in 1921 and had bounced back." Yes it did, and it did so amid reductions in government spending alongside a strong commitment to the gold standard. Whether or not Keynes was right about the way in which the world returned to gold will continue to be debated, but it's increasingly apparent that his top-down notions of how economies grow delayed economic recovery in the ‘30s with catastrophic results as evidenced by World War II.
Despite my objections, it can't be stressed enough what an interesting, worthwhile read Lords of Finance is. Ahamed's work is a triumph of economic history, one that this writer found hard to put down.
