Lords of Finance

It was a total miscalculation. Von Havenstein failed to recognize that experimenting with the currency was like walking a knife-edge. A moderate degree of inflation does not remain moderate for long. At some point the public loses confidence in the authority’s power to maintain the value of money, and deserts the currency in panic. Germany passed this tipping point in the middle of 1921.

Instead of admitting that he had made a terrible mistake, Von Havenstein, with his dogged Prussian sense of duty, dug in his heels, refusing to change any of his policies and continuing to print as much money as the government “needed.” The inflation had initially been beneficial to private business because it had the effect of wiping out their debts. By 1923, however, the crisis had moved to a new stage, and without a functioning currency, commerce became impossible. Unemployment, which had hovered around 3 percent suddenly shot up to 20 percent in the fall of 1923. In order to maintain some illusion of solvency, Von Havenstein began to pump Reichsbank money directly to private businesses. He hid behind the claim that, but for reparations, there would be no inflation in Germany and therefore put the blame for the inflation on the rapacious demands of foreigners. He began arguing that the inflation had nothing to do with him, that he was a passive bystander to the whole process, that his task was simply to make enough money available to grease the wheels of commerce, and if business required a trillion more marks, then it was his job to make sure they were run off the presses and efficiently distributed around the country.

On August 17, 1923, he delivered his annual report on economic conditions before the Council of State:The Reichsbank today issues 20,000 milliard marks of new money daily, of which 5,000 milliards are in large denominations. In the next week the bank will have increased this to 46,000 milliards daily, of which 18,000 milliards will be in large denominations. The total issue at present amounts to 63,000 milliards. In a few days we shall therefore be able to issue in one day two-thirds of the total circulation.

Here was the president of the Reichsbank, whose principal obligation was supposed be the preservation of the value of the currency, proudly proclaiming to a group of parliamentarians that he now had the capacity to expand the money supply by over 60 percent in a single day and flood the country with even more paper. For many people, it was just one more sign that German finance had entered an Alice-in-Wonderland phantasmagoria.

“No-one could anticipate such an ingenious revelation of extreme folly to which ignorance and false theory could lead . . . The Reichbank’s own demented inspirations give stabilization no chance,” wrote the British ambassador, Lord d’Abernon, an expert on state bankruptcies who had thought that he surely had to have witnessed the worst financial excesses in the lunacies of the Egyptian khedives and the Ottoman Turks, only to find them almost Swiss in their rectitude compared to the Germany of 1923. “It appears almost impossible to hope for the recovery of a country where such things are possible. It is certainly vain to hope for it unless power is taken entirely from the lunatics presently in charge.”

WHEN THE WAR ENDED, Hjalmar Schacht was just a modestly successful banker, not yet especially distinguished or rich. It was the opportunities thrown up by inflation that would make him powerful and wealthy. He certainly did not make money by speculating himself—having grown up poor, he was very conservative and took few risks with his own savings. He was, however, lucky.

In 1918, he recruited a thirty-six-year-old stockbroker, Jacob Goldschmidt, to join the Nationalbank. Goldschmidt was talented, cultivated, and charming, very different from the traditional conservative bankers of Berlin, a self-made millionaire who had built a successful stock exchange trading firm. Once at the Nationalbank, Goldschmidt began playing the market with large amounts of the bank’s capital, and by engineering a series of astute mergers, he transformed the bank, now named the Danatbank, into the third largest banking conglomerate in Germany. By 1923, Schacht had suddenly been vaulted into the upper reaches of the Berlin banking establishment.

In the summer of 1923, he stood at his office window contemplating the scene below. While most of the other large Berlin banks were housed along the Behrenstrasse in somber gray buildings with great rusticated stone walls and massive pillars and pilasters, the Danatbank had chosen for its headquarters a charming red sandstone building overlooking a quiet square on the banks of the Spree. His own office commanded a perfect view of the square below, in the center of which stood a small bronze statue of Karl Friedrich Schinkel, the architect who had designed so much of Berlin—a strangely tranquil scene, he reflected, far removed from the fever gripping the rest of the city.

A constant reminder of what had happened to Germany loomed eastward across the canal: the Berliner Schloss, for almost five centuries the home of the Hohenzollern kings. The vast imperial palace of over 1,200 rooms, its grand dome dominating the landscape for miles, now stood empty, its contents looted and ransacked, its beautiful balconies splintered and shattered, its Baroque façade disfigured by large pallid patches where artillery shells had struck during the 1918 revolution.

Schacht had become increasingly ambivalent about the new republican Germany. In no way nostalgic about the past, he felt no regret at the passing of empire, with its “old style Prussian militarism”

that sought to impose a “permanent order of society.” But proud and nationalistic as he was, he did look back to the times before the war when Germany had been a nation of order and discipline, the economic powerhouse of Europe. The country was, in his view, now destroying itself pointlessly. The republic had betrayed the professional middle classes, which had once made Germany so strong. The Fatherland had become a “hell’s kitchen.”

Though he now had the money and position he had so long scrambled to acquire, Schacht felt frustrated. At the Danatbank, he had been sidelined by the more successful Goldschmidt. By writing articles in the Berliner Tageblatt and the Vossische Zeitung, he had developed something of a reputation as an expert on reparations, arguing that Germany could and should pay no more than $200 million a year, equivalent to a total reparations settlement of $4 billion, a third of what had been agreed to in London in 1921. It was an amount that at the time would have been completely unacceptable to France. He tried to have it both ways. At the same time he was taking a hard line on the level of reparations that Germany could pay, he would urge the government to be more pragmatic, to open negotiations with the French, abandon the failed policy of passive resistance in the Ruhr, and cease printing money.

Had he been honest with himself, he would have had to admit that he was lucky not to have been involved. Over the last three years, as the country had sunk into economic chaos, reparations had been a no-win issue for any German politician or official.

8. UNCLE SHYLOCK

War Debts

Neither a borrower, nor a lender be; for loan oft loses both itself and friend.

—WILLIAM SHAKESPEARE, Hamlet

THE problem of collecting reparations from Germany was made infinitely more complex by that of war debts owed to the United States. Britain had gone to war as “the world’s banker,” controlling over $20 billion in foreign investments. No other financial center—neither Berlin nor Paris, certainly not New York—came close to matching London’s standing as the hub of international finance. Through it passed two-thirds of the trade credit that kept goods flowing around the globe and half the world’s long-term investments—over $500 million a year. Meanwhile, France, though never so dominant a financial power, had its own overseas portfolio of $9 billion, of which an astounding $5 billion was invested in Russia.

To pay for the four long, destructive years just past, every country in Europe had tried to borrow as much as it could from wherever it could. The effect was to create a seismic shift in the flow of capital around the world. Both Britain and France were forced to liquidate a huge proportion of their holdings abroad to pay for essential imports of raw materials, and both eventually resorted to large-scale borrowing from the United States. By the end of the war, the European allied powers—sixteen countries in all—owed the United States about $12 billion, of which a little under $5 billion was due from Britain and $4 billion from France. In its own turn, Britain was owed some $11 billion by seventeen countries, $3 billion of it by France and $2.5 billion by Russia, a debt essentially uncollectible after the Bolshevik revolution.

At an early stage of the Paris Peace Conference, both the British and the French tried to link reparations to their war debts, indicating that they might be prepared to moderate their demands for reparations if the United States would forgive some of what they owed America. The United States reacted strongly, insisting that the two issues were separate. Its delegates, many of them lawyers, including the secretary of state, Robert Lansing, made a clear moral and legal distinction between reparations, which resembled a fine and were intended to be punitive, and war debts, which were contractual liabilities voluntarily entered into by the European Allies. The Europeans, less wedded to legal modes of thought, failed to see either the moral or the practical distinction between their obligations to the United States and Germany’s obligations to them. Both would be burdensome and both would require material sacrifice for several generations.

As the Peace Conference was winding to its end, Maynard Keynes, distressed at how the negotiations were going, decided on his own initiative to put together a comprehensive plan for the financial reconstruction of Europe. Reparations should be fixed at $5 billion, to be paid by Germany in the form of long-term bonds issued to the Allies, which they would in turn assign to pay their war debts to the U.S government. All other obligations were to be forgiven. It was a clever scheme. The U.S. government would be functionally lending Germany money, which in turn would go to pay reparations to the Allies, who in turn would use those proceeds to settle their loans. The money would start in a United States flush with gold, and eventually return there full circle.

Keynes passed the plan on to the chancellor of the exchequer, Austen Chamberlain, who in turn recommended it to Lloyd George. The prime minister received Keynes’s plan just as he was beginning to realize the extent of his tactical errors over reparations and, in a short burst of enthusiasm, submitted it to President Wilson. It was rejected out of hand by the American delegates, who continued to insist that war debts must not be linked to reparations and that the former could not be forgiven on such a scale. And thus the problem of reparations and war debts would be allowed to fester over the maimed economic body of Europe.

TEN DAYS AFTER the armistice of November 11, 1918, Benjamin Strong wrote to Montagu Norman, “The principal danger now ahead of us . . . is not social and political unrest” but that the coming peace negotiations would “develop along lines of economic strife” that would lead to “a period of economic barbarism which will menace our prosperity.” “There is no doubt,” he continued, “that much of the world’s happiness in the future will depend upon the relations now being established between your country and ours.” Over the next decade that compact between Britain and the United States—or rather between the Bank of England and the Federal Reserve—built upon the friendship between Norman and Strong, would be one of the fixed points of the world’s financial architecture.

The two of them came to that compact from very different directions. For Norman, it was a matter of simple necessity. The war had devastated Britain economically; and, he believed, only by acting in conjunction with the Americans could Britain hope to regain its old financial influence. For Strong, the calculation was a little more complicated. As a banker from the Morgan fold, he was naturally an internationalist. The war had brought a new recognition among U.S. financiers that the fate of their country was inextricably linked to that of Europe. Now, with the arrival of peace, he believed that it was in its own interest for the United States to use some of its huge resources to “help to rebuild a devastated Europe.”

There was also a moral imperative to Strong’s internationalism. He was part of that generation of Americans who, having begun their careers under Theodore Roosevelt and having reached maturity under Woodrow Wilson, viewed themselves and their country as now uniquely qualified and positioned, by virtue of money and ideas, to transform the conduct of international affairs. He was, of course, not so naive that he did not recognize that many Europeans remained cynical about U.S. motives—accusing it, for example, of having deliberately waited until Europe had come close to bankruptcy before entering the war. He, however, was one of those who believed that now that the war was over, his nation had a unique opportunity to show that it was truly, in his own words, an unusually “unselfish, generous people.”

He was especially influenced in his sense of high purpose about America’s world mission by a group of young men with whom he had become friends who went by the mysterious name “The Family.” Based in Washington, The Family was an exclusive private club, which he had been invited to join before the war. It had no official name, was indeed not really a club at all—no officers, no charter, no formal membership roll. It had come into being in 1902 when three young army officers, captains Frank McCoy, Sherwood Cheney, and James Logan, all in their early thirties, attracted to Washington by Theodore Roosevelt’s “call to youth,” decided to rent a house together at 1718 H Street. This soon became a gathering spot for ambitious young diplomats and service officers, all similarly inspired by Roosevelt’s vision of a muscular U.S. foreign policy. In the absence of a formal name, it came to be known as the 1718 Club or The Family.18

The membership progressively widened to include a more eclectic circle, including journalists, such as Arthur Page, editor of the popular monthly The World ’s Work; politicians, like Congressman Andrew Peters, who would become mayor of Boston; and bankers, such as Strong. Over the years, though, The Family had remained an extraordinarily tight-knit group who kept in close touch with one another, particularly during the war. When the fighting finally stopped, many members found themselves thrown into the peace negotiations.

No one was more emblematic of the ethos of The Family than Willard Straight, a flamboyant charmer whose life reads like something out of a boy’s adventure novel. Early orphaned, Straight had graduated from Cornell, gone out to China, where he learned Mandarin, served as a reporter during the Russo-Japanese war of 1904, become secretary to the American legation in Korea, been appointed consul general in Manchuria, and joined a Morgan-led bank in China, all by the age of thirty. Thereafter he had married an heiress, Dorothy Whitney; helped found the New Republic; seen army service in France; and with the armistice, joined the advance team in Paris to prepare for the forthcoming Peace Conference. Tragically, he contracted influenza during the 1918 pandemic and died suddenly in December 1918, at the age of thirty-eight.

Another memb

er, Joseph Grew, had been in Germany as the number two in the embassy during the first years of the war, had gone on to become the State Department’s desk officer for Germany, and was now leading the advance team in Paris. William Phillips, who came from a rich family and had rejected a “pallid career” in business to become a career foreign service officer, became a Far Eastern specialist after assignment to Peking. Subsequently posted to London, he was now an assistant secretary of state. Another foreign service hand, Basil Miles, a particularly close friend of Strong’s, had taken his degree at Oxford, been posted to Petrograd in 1914, and was now State’s prime expert on Russia.