Lords of Finance

The French financial situation was exacerbated by a hopelessly primitive system of public accounts. Despite its much vaunted corps of inspecteurs des finances, there were huge gaps in its books and no one seemed to know precisely how much had been spent during the war, on what and by whom. It was even hard to reckon the total amount of borrowings—in 1922, an audit discovered that the volume of National Defense Bonds issued had been overestimated by the equivalent of $500 million. Controls over money flowing in and out of the treasury were so rudimentary that during the coming crisis, in a swindle that was never to be solved, $150 million of National Defense Bonds that were generally issued in bearer form and therefore untraceable, disappeared mysteriously from the treasury—in relative terms the equivalent today would be a fraud of $30 billion.

But unlike its German counterpart, the Banque de France was determined to reassert its independence after the war and refused to float the government any longer. Though the French government was able to borrow in the open market because of the high savings rate of its citizens, most of the debt was short term, had to be constantly rolled over, and the government was forced to live a sort of hand-to-mouth existence, always nervous that suddenly its creditors would get fed up and go on a lending strike.

Before the war, there had been just over 5 French francs to the dollar. By the early 1920s, following the wartime trebling of French prices, the franc had stabilized at about a third of its prewar level, about 15 to the dollar. During the latter half of 1923, it became apparent that the invasion of the Ruhr had been a failure and the likelihood of France being able to cover its budget deficit from reparations was increasingly remote. By the beginning of 1924, the exchange rate had fallen to 20 francs to the dollar.

On January 14, the day the Dawes Committee, as it was now being called, began its deliberations, the exchange value of the franc plunged by around 10 percent in a single day. Though it appeared to steady during the next few weeks, it began falling again after mid-February and in two days, March 6 and 7, lost another 10 percent, reaching 27 francs to the dollar on March 8. There were scenes of pandemonium in the Salle des Banquiers at the Bourse as a wildly gesticulating crowd of currency brokers and bankers’ agents frantically tried to unload their francs.

The authorities were adamant that foreign speculators, orchestrated in a grand conspiracy by the German government, were to blame. Convinced that finance had become war by other means, officials resorted to military analogies. Prime Minister Poincaré declared in the National Assembly that he had in his possession a secret document outlining a “plan for an offensive against the franc,” which Stresemann was supposed to have circulated to a conclave of German bankers at the Hotel Adlon. The “attack” was to be “launched” from Amsterdam, where German business houses had allegedly accumulated a reserve fund of 13 billion francs. It was reported in a U.S. newspaper that the Lutheran pastors of America had received a letter suggesting that they urge their flock to dump francs in order to “assist in bringing France to her knees.” The French were then, and would remain for many decades, obsessed with the specter of foreign speculators. Keynes described their attitude in the preface specially written for the French edition the Tract on Monetary Reform: “Each time the franc loses value, the Minister of Finance is convinced that the fact arises from everything but economic causes. He attributes it to the presence of a foreigner in the neighborhood of the Bourse or to the mysterious and malignant influences of speculation. This is not far removed intellectually from an African witch doctor’s ascription of cattle disease to the ‘evil eye’ of a bystander and of bad weather to the unsatisfied appetites of an idol.”

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 conditions attached were made public, including the usual clauses about the government taking steps to balance its budget, reduce expenditures, and float no new loans. But it was also rumored that Morgans, normally considered one of the most pro-French of all American investment houses, had also secretly insisted that the French government bind itself to accepting whatever plan the Dawes Committee might issue. Just the announcement of the loan was enough to turn things around and the franc rebounded from 29 to 18 to the dollar, an appreciation of more than 60 percent in two weeks.

As for Germany, the Dawes Committee quickly recognized that much had changed in the month since it had been appointed. The economic situation had been transformed: the currency was stabilized and the budget was swinging back into balance. Meanwhile, everyone was acclaiming Schacht “the miracle worker.”

In the middle of January 1924, Schacht, by now back in Berlin, received an invitation—he called it a “summons”—to appear before the committee in Paris. Arriving on Saturday, January 19, he made the first of his many presentations to the experts at the Hotel Astoria that same afternoon. As he sat on a “stool of repentance” in the middle of the room, like a prisoner in the dock, with the experts ranked before him like hanging judges, it was hard for him to hide his resentment at his country’s future being determined in a converted hotel dining room in Paris.

On Monday, January 21, he appeared again for three hours, and testified the next day as well. Although he grumbled that all these presentations were taking him away from the important business of getting the German currency into shape, he clearly relished the spotlight. Speaking without notes, he described the situation in Germany in 1919, “drained dry by the war”: the impact of reparations and inflation, the currency reform, the workings of the new Rentenmark, and the plans for the new gold discount bank he was putting together. As he responded in fluent French or English to the committee’s questions, he found it hard to keep that inevitable note of self-congratulation out of his replies. “His pride is equaled only by his ability and desire for domination,” wrote Dawes in his journal that evening. Nevertheless, the committee could not help being impressed by his grasp of the situation.

Alerted from the start to the size of Schacht’s ego—Dawes noting that the most “remarkable revelation of character” came when Schacht baldly told the commission, “As long he was President [of the Reichsbank], he was the Bank”—the committee went out of its way to court him and involve him at every stage in their deliberations.

It decided that it was essential to get Schacht on board in any scheme of foreign supervision of German monetary policy. It dared not risk a confrontation that might undermine or derail his very successful efforts to stabilize the currency, thus provoking a flight of capital that would only compound its difficulties; but it also feared that if it allowed him to get too far ahead of it in his own plans, it might later prove difficult to rein him in.

In the space of only two months, Schacht had gone from being a relatively obscure banker to becoming the key German official to deal with, the man who could deliver. Alexandre Millerand, the president of the republic, invited him to the Élysée. It was even strongly suggested that he call on the germanophobe Poincaré, instigator of the Ruhr invasion. When Schacht declared that he was open to such an invitation, he was told that protocol required that he take the initiative by requesting an audience. He duly complied, presenting himself punctually at 5:00 p.m. one evening at Poincaré’s offices on the Quai d’Orsay; but when the prime minister kept him waiting for thirty minutes, Schacht, prickly as ever, stormed out and had to be coaxed back by a group of alarmed functionaries.

On January 31, the committee of experts traveled to Berlin by special train, the first train to go directly from Paris to Berlin since the war, to see for itself the hardships wrough

t thus far by reparations. German officials, keen to ensure that the visitors obtain enough of an impression of their people’s privations, arranged for the electricity in the hotels housing the commission to be deliberately shut off early.

In dealing with the committee, Schacht faced a real dilemma. On the one hand, he was enough of a realist to recognize that while it needed him, he could not afford to alienate it. He could only go so far on his own. Only a group of foreign experts would have the stature to negotiate lower reparations or make it possible to mobilize a foreign loan. Typically, though, one of his biggest concerns seems to have been that the foreigners might try to take the credit for his achievements.

On the other hand, he remained convinced that Germany could not afford to pay anywhere close to the reparations envisaged by the London schedule. He believed that the Dawes approach of not tampering with the total amount of obligations was fundamentally flawed. For the moment, however, he held his peace. Over the next few weeks, Schacht became the critical German interlocutor for the committee when it came to financial reform and the Reichsbank. Although mutual interest kept both parties scrupulously polite to each other, there nevertheless remained an undercurrent of tension in their dealings.

On April 9, the committee issued its plan. As Young had insisted, it very deliberately avoided pronouncing either on the total amount of reparations that Germany should owe or the period over which they should be paid, but focused purely on what should be paid over the next few years. It proposed that Germany begin at $250 million in the first year, and progressively increase the amount to $600 million a year by the end of the decade. By one calculation, using some plausible assumptions about the total period over which Germany might remain obligated, the practical effect of the Dawes Plan was to reduce Germany’s debt from $12.5 billion to around $8 to $10 billion.

But the plan’s most novel feature was to put in place an ingenious mechanism to ensure that reparations could not undermine the mark as they had in 1922-23. The money to pay reparations was to be raised initially in marks by the German government and paid into a special escrow account in the Reichsbank, where it would fall under the control of an agent-general for reparations who would be responsible for deciding whether these funds could be safely transferred abroad without disrupting the value of the mark. The power was vested in this new office to decide how these funds should be put to use—whether to be paid out abroad, used to buy German goods, or even to provide credit to local businesses. The agent-general would be in a remarkably strong position, a sort of economic proconsul or viceroy. To make his impartiality completely transparent, the committee recommended that he be an American.

A second and ultimately the central feature of the Dawes Plan was that a loan of $200 million be raised abroad to help pay the first year of reparations, to recapitalize the Reichsbank and build up enough gold reserves to jump-start the domestic economy.

Although the French pressed to move the Reichsbank totally out of Germany, possibly to Amsterdam, the rest of the committee recognized that this would be the ultimate humiliation, putting Germany on the same footing as the indigent nations of Egypt and Turkey—in the words of one participant, it would “turkify” the German economy. Instead, the committee managed to persuade all parties, even the French and the Germans, that the Reichsbank should be kept in Berlin but placed under the control of a fourteen-member board, seven foreigners and seven Germans, one of whom would of course be Schacht.

IN July 1924, the allies convened a conference in London on how to implement the Dawes Plan. It was the greatest gathering of statesmen since the Paris Peace Conference of 1919. Ramsay MacDonald, the first Socialist prime minister of Britain, who doubled as his own foreign secretary, presided. Among his guests were Édouard Herriot, the new Radical prime minister of France, the prime ministers of Belgium and of Italy, and the ambassador of Japan. The United States had initially planned not to attend, for fear of being tainted by too close an association with reparations, then viewed as a horrible European disease. However, when the British government allowed its official invitation to the United States to be leaked, the Coolidge administration, which had played such an important part in getting the Dawes Plan started, felt that it could not refuse without undermining its own efforts, and decided on a public show of support. Frank Kellogg, the white-haired U.S. ambassador to Great Britain, was assigned to lead the U.S. delegation.

Such was the interest within the administration in the outcome of the Dawes Plan, that several cabinet members contrived to find excuses to be in London. Charles Evans Hughes, the secretary of state, arrived ostensibly to attend the annual meeting of the American Bar Association, while Andrew Mellon, the secretary of the treasury, decided that this was an opportune moment to pass through London for some grouse shooting and possibly to see his Savile Row tailor.

Despite all these political luminaries, the central figures in the negotiations were to be two bankers: Montagu Norman and Thomas Lamont of J. P. Morgan & Co. Norman had been at first skeptical of the Dawes Committee. Asked by the prime minister to be one of the British delegates, he had begged off with the excuse that he was too busy at the Bank. If past experience was anything to go by, any committee appointed by the Reparations Commission was bound to get bogged down in political wrangling and would end up deadlocked. As he wrote to Strong, “It looks to me as if that Committee will be finding themselves in great difficulties . . . it is clear that there are as many angles of vision as there are members on that committee.”

But during February and March, as the nature of the Dawes Committee’s recommendations gradually filtered out, he had begun to change his mind. The heart of the plan, and the reparations settlement it envisaged, was the international loan, over whose terms, Norman realized, he was in a position to exert enormous leverage.

The business of lending to foreign governments was historically one of the more glamorous aspects of banking. Before the war, lending had been firmly in the hands of two British banks with long and storied histories—Baring Brothers and Rothschilds.

Barings was the oldest merchant bank in London—the male descendants of all five of the sons of the original founder, Thomas Baring, now sat in the House of Lords. In 1802, it had helped the U.S. government finance the purchase of the Louisiana Territory from a Napoléon desperate for cash. So great was its authority at one time, that the Duc de Richelieu in 1817 spoke of the “six main powers in Europe; Britain, France, Austria-Hungary, Russia, Prussia and Baring Brothers.”

Rothschilds had had an even more eventful history. The family had made its fortune during the Napoleonic Wars. With five branches of the family spread across Europe—in London, Paris, Frankfurt, Vienna, and Naples—it had the most extensive network of contacts of any bank, and its sources of information were legendary. One story was that the family had learned, by homing pigeon, of Napoléon’s defeat at Waterloo a day before the rest of London, including before the government itself, and had made an enormous fortune by buying up government bonds. The story was, in fact, seriously wrong—although Rothschilds did learn of the victory before anyone else in London, it actually lost money from betting that the war would still go on for a while by having large amounts of gold bullion in stock—but the myth remained. So great was the Rothschild mystique that the economist J. A. Hobson, echoing a widely shared opinion, wrote in 1902 that no great war could be “undertaken by any European state . . . if the house of Rothschild and its connections set their face against it.”

But after the war, with London itself short of capital, the Bank of England had had to impose an unofficial embargo on foreign loans by British houses, and both banks were shadows of their former selves. The mantle of “Banker to the World” shifted from Britain to the United States, though American money, unused to the vagaries of international politics, flowed in fits and starts. The three American firms that had come to dominate the sovereign loan market were the National City Bank, Kuhn Loeb, and—not the largest but the most prestigious—J. P. Morgan & Co.

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. Chosen as the sole purchasing agent of both the British and the French governments in 1914, it had become a power unto itself. Its fourteen partners, who sat together in a large gloomy common office where they could overhear one another’s conversations, now supposedly earned an average of $2 million a year. When the war ended, Morgans became the natural conduit of American money into Europe. Its status as one of the great powers to be reckoned with was confirmed in July 1920, when a group of anarchists, instead of targeting a head of state or government as it might have done before the war, chose to place a bomb outside the offices of J. P. Morgan & Co. at 23 Wall Street.25 The partners were unscathed, but thirty-eight bystanders were killed and another four hundred injured.