Lords of Finance

As the conference stretched into its sixth week, a sour and cynical mood began to pervade its halls. Lord Revelstoke complained in his diary that the sessions were “lengthy, tiresome and far from satisfactory. Schacht resumes his most negative attitude, is unhelpful to the last degree.” One of the journalists present described Schacht, storming out of meetings with threats to abort the talks, as “a vehement, intolerant man; excitable and dogmatic; . . . the most tactless, the most aggressive and the most irascible person I ever have seen in public life.” He alienated all the other delegates with his “tantrums and exhibitionism.” Revelstoke thought that with his “hatchet, Teuton face and burly neck and badly fitting collar” he looked like a “sea lion at the Zoo.”

Moreau by contrast sat there obstinate and ill-tempered, his mouth shut, Revelstoke observed, “like a steel trap w

hen Schacht pleads poverty and inability to pay.” As Moreau watched the Germans become more isolated, he tried to keep quiet and let them dig their own graves. But eventually, unable to restrain himself, he exploded and publicly accused Schacht of negotiating in bad faith. Jack Morgan, bored with the sort of details he generally left to underlings and shaken by his one attempt to try to reason with Schacht, left for a cruise on his yacht around the Adriatic and the Aegean with the archbishop of Canterbury, complaining that, “If Hell is anything like Paris and an International Conference combined, it has many terrors and I shall try to avoid them.”

The German delegates found the atmosphere in Paris menacing. They were not being paranoid. The French secret police were tapping their phones. All communications with their government had to be conducted by courier or by cipher telegrams, with each of the twenty-eight participants assigned a code name. The three senior representatives, Schacht included, took turns traveling back to Berlin by train every two weeks in order to brief the cabinet.

Finally, in early April, Young felt ready to allow the Allies to unveil their proposal. Germany would have to make annual payments of $525 million for the first thirty-seven years and, in order to match exactly the Allied war debts to the United States, $400 million a year for the subsequent twenty-one years. The Allies made it clear that the only reason they were saddling two generations of Germans with reparations was that they themselves were in debt to the Americans for the same length of time. On hearing the Allied proposal, Schacht turned pale and, in a voice trembling in anger, declared the session terminated.

By now he realized how totally he had miscalculated. The American bankers’ power to pressure the Allies had foundered on the U.S. government’s unwillingness to contemplate any further reduction in war debts. Without such an easing, the Allies would not reduce their claims on Germany. Schacht was now caught between letting the conference collapse thus very likely provoking a financial crisis in Germany for which he would be blamed, or settling for the terms on offer, for which he feared he would be equally vilified.

Schacht had always been a gambler. In a desperate effort to win more options, he decided to change the German offer radically. He had always believed that one of the greatest injustices of Versailles had been the seizure of Germany’s colonies—an odd collection of territories that Germany, late to the scramble for empire, had accumulated, including most of Samoa, part of New Guinea, Togoland, German South-West Africa, the Cameroons, and Tanganyika—which Schacht implausibly claimed had been worth $20 billion to Germany, an amount that overshadowed even the bill for reparations. He now argued that Germany would be unable to meet the victors’ demands unless its former colonies were restored. Even more provocatively, he demanded that the Danzig corridor, the most contentious strip of land in all Europe, taken from Germany to give Poland access to the sea, should also be returned.

In seeking to tack what amounted to a territorial revision of Versailles upon what was supposed to have been a purely financial negotiation, Schacht had gone out on a limb, and without the permission, or even the knowledge, of his own government. The détente between Germany and the Allies, so painstakingly achieved since the withdrawal from the Ruhr five years before, had rested on the principle that Germany would not seek to overturn the political or territorial clauses of the 1919 settlement. Here was Schacht in one stroke trying to undermine the whole fragile basis of European peace.

It has always been something of a mystery what Schacht was hoping to achieve. He did have a habit of shaking things up without quite knowing where it would all end. But he must have known that no one at the Young Conference had the authority to renegotiate crucial parts of the Treaty of Versailles, that the gambit was bound to end in failure. Some thought he was just grandstanding for domestic consumption to prepare for a political career on his return to Germany, others that he was just trying to provoke a crisis to give himself a smoke screen to avoid taking the blame for the poor deal for Germany.

Schacht’s proposal was initially received in stunned silence. Once the other delegates had had time to absorb his demands—and he had made them sound like an ultimatum—the table dissolved into an uproar, with cries of astonishment and outrage. Moreau was so furious that he pounded the table and, in a rage, flung his ink blotter across the room.

With the conference now close to collapse, Pierre Quesnay of the Banque de France told one of the Americans that evening that French depositors would withdraw $200 million from German banks by noon the next day. It was unclear whether this was intended as a threat or a prediction. In any case, Germany suddenly began to lose gold at an accelerating pace—$100 million over the next ten days, forcing the Reichsbank to raise rates to 7.5 percent, despite Germany’s being deep in recession, with two million unemployed.

Seeing this as the first salvo in an economic war, Schacht accused the Banque de France of having secretly orchestrated the withdrawals to force his hand and threatened that if Germany’s reserves continued to fall, he would have no option but to invoke the transfer clause of the Dawes Plan to default on all further reparations. At that moment, such a move would have set off a global financial meltdown. German banks, municipalities, and corporations owed money to everybody—$500 million to British banks, several hundred million to French banks, and some $1.5 billion to American lenders. Had it defaulted on reparations at that point, every financial institution with exposure to Germany would have tried to pull what money it could out of the country. Germany would have had to suspend payments on all its commercial loans, creating a domino effect across the globe. Half the London banks would have gone under. Britain, its reserves already depleted, would have been flung off the gold standard. The financial chaos would have been catastrophic.

The Banque de France had in fact considered launching such a preemptive financial strike against Germany but rejected the idea as too risky. Moreau did not want to be blamed for a world economic collapse. Some French banks undoubtedly did pull some deposits home but this was mere commercial prudence in the light of the deteriorating turn of events. Meanwhile, in an effort to forestall a breakdown in world finances, Norman and George Harrison of the New York Fed had begun mobilizing money to support the Reichsbank.

At this point, with a financial crisis looming, Lord Revelstoke saved the day by suddenly dropping dead. The consequent suspension of the proceedings forced the parties to catch their breath for a few days and step away from the brink. Schacht left with the German delegation for consultations in Berlin. There he found the cabinet up in arms. He had clearly overreached. The foreign minister, Stresemann, who had repeatedly tried to warn Schacht not to overstep his authority, feared that he might have jeopardized Germany’s still very delicate political position. Other ministers were alarmed about the domestic economic ramifications. Not only had unemployment already reached two million, but a wave of strikes was now threatening to put another million men out of work. Schacht’s gamble threatened to plunge Germany into even deeper recession.

Schacht fought back. He blamed Gilbert for having misled him. He even turned on his erstwhile patron Stresemann, whom he accused of having undercut him by caving in to the Allies behind his back even before the conference had started and of now making him the scapegoat for the political fallout at home.

While Schacht, even at this stage, would have been willing to go for broke and risk a global banking crisis, his government was not. Fearing that Germany would once again become a pariah nation, the cabinet disavowed his position, forced him to recant, and insisted that he return to Paris and resume negotiations on the basis of the last Allied proposal. He reluctantly agreed, provided the cabinet gave him political cover by publicly accepting final responsibility for any settlement. Schacht had no intention of ending up as the fall guy for what nationalists were bound to see as a sellout.

The German delegation returned to the table. In the middle of May, negotiations were again suspended for few days—though this time it was so that Moreau could return to fight the mayoral elections in his tiny hamlet of Saint Léomer. A few weeks later a compromise was reached. Germany would pay a little under $500 million for the next thirty-six years and $375 million a year for the twenty-two after that to cover the Allies debt to the United States. A new bank, the Bank of International Settlements (BIS), jointly owned by all the major central banks, would be set up to administer and where possible to “commercialize”—the modern term is securitize—these future payments, that is, to issue bonds against them. Any profits generated by the Bank were to accrue to Germany to help defray the burden. All foreign control over German economic policy was to be removed—Gilbert could pack his bags and join Morgans. The transfer protection clause was eliminated, although a small safety valve was retained whereby should Germany get into economic trouble, it could postpone two-thirds of its payments for two years.

In the circumstances, this was truly the best deal that Schacht could get. As the delegates gathered for the signing ceremony in the meeting room of the George V, the curtains suddenly burst into flame—the photographers lights had caused them to overheat. Schacht saw it as an omen. He had been humiliated in the negotiations and, on his return to Germany, was criticized from all sides—from the left, for having risked the future of Germany on a gamble that had gone badly wrong, and from the right, for having put his signature to a bill that would “shackle” the next two generations. Even his wife greeted him at the station with the words, “You ought never to have signed.” And though he publicly supported the Young Plan, in private he painted a much darker picture of the future

. “The crisis may have been postponed for another two years, but it will arrive with the same certainty and with even greater severity.” In the ensuing financial chaos, he foresaw that “Germany will be cut off from all foreign capital for a long time, maybe two to three years. For all segments of the German people this will mean managing without, longer working hours, lower wages.” An ominous prediction, accurate to the year.

THAT OTHER GREAT pessimist on reparations, Maynard Keynes, shared Schacht’s view of the new arrangements. Believing that Germany would find it difficult to keep borrowing its way out of its hole, Keynes responded to the new plan by proclaiming, “My prophecy would be that the Young Plan will not prove practicable for even a short period . . . and I should not be surprised to see some sort of crisis in 1930.”

Marriage had mellowed Keynes. Confounding all the clever predictions of his sophisticated friends, he and Lydia had settled into a blissfully happy union. He commuted between the London apartment in Gordon Square, where they lived during the week; his bachelor rooms in college at Kings on the weekends; and their country house at Tilton in Kent, during the holidays. Though less prolific with articles on current affairs, he had not completely retired from his position as the premier gadfly of economic orthodoxy.

But for the last four years, he had been hard at work on a new book. After The Economic Consequences of the Peace and A Tract on Monetary Reform, both monographs devoted to the immediate and practical concerns of the chaotic postwar world, he was now struggling with a more ambitious work, a theoretical treatise on the interactions between the monetary sphere—the world of banks and other financial institutions—and the underlying real economy—the world of stores and factories and farms. He had begun this line of thought in the Tract, but that had been built on a very simple picture, almost a cartoon, of the economy. In this new book, he was trying to paint a richer portrait of the paths along which money flowed in order to understand better the fundamental source of the instability he believed to be inherent in the credit system of modern capitalism.

He also remained an active speculator, an exhausting and dangerous pastime in that turbulent decade. As the bursar of Kings, he managed a pool of money for the college; he was chairman of the board of the National Mutual Insurance Company; and he had set up several investment companies with his friend, Oswald Falk, head of the London stockbroking firm of Buckmaster and Moore. In addition, he continued to manage his own money very actively, usually from the vantage point of his bed in the morning. Buying and selling on margin, he was able to leverage his positions substantially and his portfolio could be very volatile. He began 1923 with about $125,000, the profits of those first forays into the foreign exchange markets. During the next five years, he doubled his money, making most of it trading commodities and currencies, rather than stocks.

Despite his reputation as a Cassandra, by early 1928, his view of the future, as reflected in his investment portfolio, was uncharacteristically sanguine. He avoided the U.S. market, but made substantial investments in the shares of British motor companies, particularly Austin and Leyland. His largest bet, however, was a very substantial complex of long positions in commodities—especially rubber, but also corn, cotton, and tin—a strategy heavily influenced by his perception of Fed policy. He thought that the American central bank under Strong had done a remarkable job, a “triumph” he called it. The Fed, while hiding behind the smoke screen of adhering to the gold standard, had managed very successfully to stabilize U.S. prices, and Keynes believed that with Strong at the helm, it could and would continue to do so.

But as 1928 progressed, his portfolio began to unravel. He sustained substantial losses in April when rubber prices collapsed by 50 percent as the world cartel broke down, forcing him to liquidate large holdings at a loss to meet margin requirements. The Fed’s tightening of early 1928 to cap the stock market took Keynes by surprise. After all, he argued, U.S. prices were stable and there was “nothing which can be called inflation yet in sight.” In September 1928, with the Dow at 240, he circulated a short note among friends titled “Is there Inflation in the U.S.?” which predicted that “stocks would not slump severely [that is,] . . . unless the market was discounting a business depression,” which the Fed “would do all in its power to avoid.”

His big error was a failure to take into account the deflationary forces that had begun to sweep the world. After Strong’s death in October and as the Fed initiated its campaign of words against the exuberance of the market, he began slowly to realize that the risk had now shifted “on the side of business depression and a deflation.” But by his own admission, even in early 1929, he still did not comprehend the impact that the scarcity of gold would have on central banks. He had thought that over time they would liberate themselves from the hold of the “barbarous relic.” He completely failed to foresee the sort of scramble for gold that emerged in 1929. “I was forgetting that gold is a fetish,” he confessed.

The price for being a speculator was that all these miscalculations wrought havoc on his net worth. By the middle of 1929, he had lost almost three-quarters of his money. The only saving grace was that in order to meet his margin payments, he was forced to liquidate much of his stock portfolio and entered the turmoil of 1929 only modestly invested in the market.

The role of Cassandra was instead taken over by Montagu Norman. Of all the various flashpoints ready to detonate in the world economy that fateful spring and summer—Germany teetering on the brink of default, the shortage of gold, falling commodity prices, the madness on the U.S. exchanges, a chronically weak sterling held hostage by the Banque de France—he found it hard to tell which was the most combustible.

In April 1929, with the negotiations in Paris deadlocked, Norman wrote, “Picture to yourself that at one and the same time a committee is laboriously discussing the whole question of German reparations in Paris: that the rate of interest was yesterday 20% in New York, where the Reserve System is not functioning and where the stock market is playing ducks and drakes with their own and other people’s money; that three of the central banks in Europe have raised their rates within the last month, perhaps only as a beginning.” The world, it seemed to him, was sleepwalking toward a precipice.

Germany, now locked out of the American market, grabbed at any and every source of credit on which it could lay its hands. In May 1929, the Swiss banker Felix Somary, nicknamed by his American colleagues the “Raven of Zurich” for his unremitting dark “croakings” of a crash to come, received a frantic call from the German finance minister, Rudolf Hilferding, desperate to borrow $20 million to pay public employees. Somary flew to Paris to finalize the necessary arrangements with Schacht, reporting back to the president of the Swiss National Bank, “Almost all the great powers have been negotiating for months about how many billions a year should be paid until 1966, and thereafter until 1988, by a country that is not even in a position to pay its own civil servants’ salaries the next day.”