Lords of Finance: The Bankers Who Broke the World

by Liaquat Ahamed

The committee should jettison the whole concept of “capacity to pay,” he argued. It was impossible to know what this number was. Too many imponderables entered into the calculation, involving such questions as: How much could taxes be raised without triggering mass protest? How tightly could imports be squeezed without precipitating a collapse in production? How far could wages be reduced without provoking labor unrest? No one could agree on the answers to such cosmic questions. What was needed was a completely new approach to the problem.

On March 13, the French government announced that J. P. Morgan & Co. had lent it $100 million on the security of its gold reserves.

the franc rebounded from 29 to 18 to the dollar, an appreciation of more than 60 percent in two weeks.

Rothschilds had had an even more eventful history. The family had made its fortune during the Napoleonic Wars.

The House of Morgan had been powerful before the war, helping to finance and restructure the steel, railway, and shipping industries; it had even bailed out the U.S. government in 1895 and saved the banking system in 1907. But its business had been largely domestic. Pierpont Morgan himself had indeed been a well-known figure in Europe, and his father, Junius Morgan, had helped the French government raise money to pay the indemnity after the Franco-Prussian war of 1870; but in international ranking, J. P. Morgan & Co. had been a second-tier house. The war had transformed its position.

fourteen partners,

Thomas Lamont,

plenary

Dawes Plan’s failure to reduce the total level of reparations was its fatal flaw. But it was Stresemann who had the final

word. “We must get the French out of the Ruhr. We must free the Rhineland. We must accept.”

The plan had therefore very deliberately swept a whole series of issues under the carpet.

Though Churchill remained chancellor until 1929, by 1927 he had come to realize that the return to gold at the old prewar exchange rate had been a misjudgment. But by then there was little he could do about it except fulminate in private about the evil effects of the gold standard. In later life, he would claim that it was “the biggest blunder in his life.” He blamed it on the bad advice he had received.

The most damaging consequence was that in a futile attempt to retain the primacy of the Bank of England and the City of London, Britain had now tied itself irretrievably to the United States.

the Banque de France

Banque de France

Even after 1875, when the republic was brought into being for the third and final time

the twelve-man Council of Regents.

Every year at 12:30 in the afternoon, on the last Thursday of January, the pinnacle of French society would gather there for the Banque’s Annual General Assembly. Though it had more than forty thousand shareholders, only the top two hundred were eligible to attend the meeting and choose the regents.

seated in alphabetical order would be some of the oldest and most aristocratic families in France: Clérel de Tocqueville, La Rochefoucauld, Noailles, Talleyrand-Périgord.

With an electorate of two hundred of the richest and grandest families in France, it was not surprising that seats on the Council of Regents came to be almost hereditary. Five out of the twelve elected regents were descendants of the original founders and a disproportionately large number were Protestants of Swiss extraction.

first convened in 1800.

the French arm of the banking empire,

eponymous

Paris Commune

Charles Rist

History of Economic Doctrines from the Physiocrats to the Present Age,

breaching 30 to the dollar, Rist and Quesnay began to worry that France might repeat the British mistake: an exchange rate that was too high, making exports chronically overpriced and uncompetitive.

Every country in Europe to emerge from the war had faced the same set of issues. Britain had chosen one extreme: to impose most of the burden on its taxpayers and to protect its savers. Germany had chosen the opposite extreme: the way of pathological inflation, which had wiped away its internal debts at the price of annihilating the savings of its middle classes. Moreau was set on finding a middle way.

he also recognized that by allowing it to rise too far, he risked driving the economy into recession.

The principle of opposition to capping the franc’s recovery did not come from the prime minister but from within Moreau’s very own institution. A faction within the Banque’s directorate, led by the two most powerful regents, Baron Édouard de Rothschild and François de Wendel, saw in the decline of the franc the decline of France.

No one better symbolized the power of les deux cents familles and le mur d’argent than these two men.

On December 21, the Banque began to purchase foreign exchange and sell its own currency to prevent the franc from rising above 25 to the dollar. For the next two years, with Poincaré’s blessing, Moreau pursued a policy of intervening in the currency market to keep it pegged there.

Unable to secure a majority within the Council of Regents, Rothschild and Wendel employed every possible tactic to undermine Moreau.

By the middle of 1927, it was clear that Moreau had won. Waves of French capital that had fled to London or New York had washed back home, allowing the Banque to accumulate a foreign exchange war chest of $500 million dollars, most of it in pounds.

At 25 francs to the dollar, French

goods were among the most competitive in the world; exports were booming, while prices were stable.

avoiding the two extremes of German-style inflation and British-style deflation.

Whatever the reason, his decision to fix the franc at an undervalued rate would eventually help to undermine the stability of the very standard to which he had now hitched his currency.

Circumstances rule men; men do not rule circumstances. —HERODOTUS, Histories

No other issue would create more debate, disagreement, feuds, and confusion within the Federal Reserve System than what to do about the stock market.

There was the erroneous notion that a rising stock market “absorbs” money from the rest of the economy. This is sheer nonsense, because for every buyer of stocks there is a seller and whatever money flows into the stock market flows immediately out.

In the fall of 1925, Miller had also become particularly alarmed by the data on so-called brokers’ loans. These were loans provided by banks to stock brokers who used the money to finance their own inventories of securities or to lend to their own customers to buy equities on margins. Typically such margin investors only paid 20 to 25 percent of the value of stocks with their own money and borrowed the rest. The total volume of such brokers’ loans, which had averaged around $1 billion in the early years of the decade, had suddenly ballooned to $2.2 billion at the end of 1924 and looked likely to reach $3.5 billion by the end of 1925. Miller saw these loans as a symptom of speculation, and he was firmly convinced that it was somehow more “inflationary” for banks to finance stock market purchases than for them to finance other activities. Again, we now know this to be fallacious—the inflationary consequences of easy credit have much more to do with the total amount the public borrows and very little to do with the purposes for which it does so.

Herbert Hoover, secretary of commerce. Hoover, a Quaker orphan from Iowa, was an engineer by profession who had graduated in the very first class from Stanford and had made a fortune in the first decade of the century as a promoter of mining ventures in every corner of the globe—from China to the Transvaal, from Siberia to the Yukon, from the Malay peninsula to Tierra del Fuego. He had come to national prominence by accident as the man in charge of evacuating Americans from Europe in 1914, then as the War Food Administrator in the Wilson administration and as the head of Belgian Relief, “the only man who emerged from the ordeal of Paris with an enhanced reputation,” according to Maynard Keynes. Appointed to the cabinet by Harding, he had distinguished himself from his do-nothing colleagues by his superb organizational ability, his belief in himself, and the constant flurry of activity that always surrounded him.

In the fall of 1925, Hoover, not shy about interfering in his cabinet colleagues’ business—Parker Gilbert called him the “Secretary of Commerce and the Under-Secretary of all other departments”—decided to launch a campaign against the pervasive atmosphere of speculation that he claimed was infecting the country, from Florida real estate to the stock market.

For both Miller and Hoover, the culprit behind this speculative fever was Benjamin Strong. They believed that his policy of keeping interest rates artificially low to help European currencies was responsible for fueling the incipient bubble. Hoover had once been a prime supporter of American engagement in European affairs following the war, and had counted Strong a good friend. But he was now convinced that the policy of propping up Europe...

Like every other financial official at the time, Strong was taken aback by the surprising strength of the stock market and was himself also worried about a potential bubble. His letters to Norman are filled with misgivings about the rise in prices on Wall Street. Though he had a somewhat jaundiced view of the stock market, dominated as it was by its motley crew of outsiders—its plungers and pool operators, all of whom were very much at the bottom of the Wall Street social ladder—he was acutely aware of its power to cause trouble. Stock market crashes and banking panics had always been closely linked in the pre-Fed world and many of the country’s past financial crises had emerged from Wall Street: 1837, 1857, 1896, a...

difficult it was to identify a market bubble—to distinguish between an advance in stock prices warranted by higher profits and a rise driven purely by market psychology. Almost by definition, there were always people who believed that the market has gone too high—the stock market depended on a diversity of opinion and for every buyer dreaming of riches in 1925, there was a seller who thought the whole thing had gone too far. Strong recognized his own highly fallible judgment about stocks was a very thin reed on which to conduct the country’s monetary policy. Even though his initial reaction was that the market might have gone too far, he asked himself, “May it not be the case the world is now entering upon a period where business developments will follow the recovery of confidence, so long lost as a result of the war? Nobody knows and I will not dare prophesy.” Given so much uncertainty, he was convinced that the Federal Reserve should not try to make itself an arbiter of equity prices. Moreover, even if he was sure that the market had entered a speculative bubble, he was conscious that the Fed had many other objectives to worry about apart from the level of the market. He feared that if he added yet another goal—preventing stock market bubbles—to the list he would overload the system.

wanted the Fed to focus on stabilizing the overall economy and was reluctant to allow its policies to be dominated by the need to regulate the “affairs of gamblers” who thronged the tip of Manhattan.

In Strong’s view, something about the American character—the exuberance, the driving optimism, the naive embrace of fads—lent itself to periods of speculative excess. “It seems a shame that the best sort of plans can be handicapped by a speculative orgy,” he mused almost philosophically to Norman at the end of 1925, “and yet the temper of the people of this country is such that these situations cannot be avoided.”

Despite the agitation from Hoover and Miller in late 1925, Strong concluded that with absolutely no signs of domestic inflation, the pound having only just returned to gold and the European currency situation still fragile, this was not the time to tighten ...