Lords of Finance: The Bankers Who Broke the World

Lords of Finance: The Bankers Who Broke the World

Liaquat Ahamed

4.03(15850 readers)
With penetrating insights for today, this vital history of the world economic collapse of the late 1920s offers unforgettable portraits of the four men whose personal and professional actions as heads of their respective central banks changed the course of the twentieth century

It is commonly believed that the Great Depression that began in 1929 resulted from a confluence of events beyond any one person’s or government’s control. In fact, as Liaquat Ahamed reveals, it was the decisions taken by a small number of central bankers that were the primary cause of the economic meltdown, the effects of which set the stage for World War II and reverberated for decades.

In Lords of Finance, we meet the neurotic and enigmatic Montagu Norman of the Bank of England, the xenophobic and suspicious Émile Moreau of the Banque de France, the arrogant yet brilliant Hjalmar Schacht of the Reichsbank, and Benjamin Strong of the Federal Reserve Bank of New York, whose façade of energy and drive masked a deeply wounded and overburdened man. After the First World War, these central bankers attempted to reconstruct the world of international finance. Despite their differences, they were united by a common fear—that the greatest threat to capitalism was inflation— and by a common vision that the solution was to turn back the clock and return the world to the gold standard.

For a brief period in the mid-1920s they appeared to have succeeded. The world’s currencies were stabilized and capital began flowing freely across the globe. But beneath the veneer of boom-town prosperity, cracks started to appear in the financial system. The gold standard that all had believed would provide an umbrella of stability proved to be a straitjacket, and the world economy began that terrible downward spiral known as the Great Depression.

As yet another period of economic turmoil makes headlines today, the Great Depression and the year 1929 remain the benchmark for true financial mayhem. Offering a new understanding of the global nature of financial crises, Lords of Finance is a potent reminder of the enormous impact that the decisions of central bankers can have, of their fallibility, and of the terrible human consequences that can result when they are wrong.

Publisher

Penguin Press

Publication Date

1/22/2009

ISBN

9781594201820

Pages

564

Categories

HistoryEconomicsPolitics

About the Author

Liaquat Ahamed

Liaquat Ahamed

Liaquat Ahamed has been a professional investment manager for 25 years. He has worked at the World Bank in Washington, D.C., and the New York based partnership of Fischer Francis Trees and Watts, where he served as Chief Executive.

He is currently an advisor to several hedge fund groups, including the Rock Creek Group and the Rohatyn Group, is a director of Aspen Insurance Co., and is on the board of Trustees of the Brookings Institution. He has degrees in economics from Harvard and Cambridge Universities.

Questions & Answers

The actions and decisions of central bankers during and after World War I significantly contributed to the economic turmoil and the Great Depression of the 1930s. The global financial system was severely damaged by the war, leading to a collapse in international trade and a surge in government debt. Central bankers' responses to these challenges were largely inadequate.

  1. Gold Standard Rigidity: Central banks, particularly in Europe, adhered to the gold standard, which limited their ability to respond to economic downturns. Deflationary policies, such as raising interest rates and reducing the money supply, exacerbated the economic crisis.

  2. Lack of Coordination: Central banks failed to coordinate their policies effectively, leading to conflicting actions that destabilized the global economy. For example, the U.S. Federal Reserve's tight monetary policy in the early 1930s worsened the depression in Europe.

  3. Failure to Address Debt: Central banks were hesitant to address the massive war debts and reparations owed by Germany, which contributed to the economic instability in Europe and the global economy.

  4. Inadequate Response to Bank Failures: During the Great Depression, central banks often failed to take decisive action to prevent bank failures, which further eroded confidence in the financial system.

  5. Keynesian Critique: John Maynard Keynes criticized the central bankers' adherence to the gold standard and their deflationary policies, advocating for active monetary and fiscal policies to stimulate economic growth. His ideas were not widely adopted until later in the depression.

In summary, the central bankers' adherence to the gold standard, lack of coordination, and failure to address the root causes of economic instability contributed significantly to the economic turmoil and the Great Depression of the 1930s.

The gold standard was a cornerstone of the international financial system during the interwar period, linking currencies to gold and ensuring stability. However, its limitations contributed significantly to the economic crisis. The gold standard constrained the ability of governments and central banks to respond to economic downturns, as they were limited by the amount of gold available. This led to deflationary pressures, as countries tried to maintain the gold standard by reducing money supply, which exacerbated economic downturns. Additionally, the gold standard's inflexibility hindered international trade and investment, as countries were unable to adjust their exchange rates to improve competitiveness. The limitations of the gold standard were evident during the Great Depression, when it contributed to the severity and duration of the crisis by preventing effective monetary policy responses.

John Maynard Keynes's policies and actions significantly diverged from those of traditional central bankers. While traditional bankers adhered to the gold standard and focused on currency stability, Keynes advocated for managed currencies and monetary policies geared towards domestic price stability and economic growth. He believed that central banks should actively manage the economy, adjusting credit and interest rates to stabilize prices and promote employment.

Keynes's ideas had a profound impact on the economic recovery. His advocacy for government intervention during the Great Depression influenced policies like the New Deal in the U.S. and the welfare state in Europe. His emphasis on fiscal stimulus and public works projects helped to boost demand and reduce unemployment. Keynes's "General Theory of Employment, Interest, and Money" laid the groundwork for modern macroeconomic theory, emphasizing the role of aggregate demand in determining economic outcomes. His ideas contributed to the understanding of economic crises and the development of policies to mitigate their effects, shaping the economic landscape for decades to come.

The rise of economic nationalism and protectionism in the 1930s was driven by several key factors. First, the aftermath of World War I left many countries with significant debts and the burden of reparations, particularly Germany. This led to economic instability and a desire for self-sufficiency, as countries sought to protect their domestic industries from foreign competition.

Second, the global economic crisis of the 1930s, sparked by the stock market crash of 1929, exacerbated these trends. The Great Depression led to high unemployment and falling wages, making imports more expensive relative to domestic goods. Governments responded by implementing protectionist measures, such as tariffs and quotas, to shield their economies from the crisis.

Third, the gold standard limited the ability of central banks to respond to the crisis by restricting their ability to increase the money supply. This contributed to deflation and further weakened economies, reinforcing the need for protectionist policies. Additionally, the rise of political movements, such as fascism and communism, which advocated for economic self-reliance, also contributed to the spread of protectionism.

These factors combined to create a self-reinforcing cycle of economic nationalism and protectionism, which worsened the global economic crisis by reducing international trade and exacerbating the economic downturn.

The Great Depression offers several critical lessons regarding central banks, monetary policy, and international economic cooperation:

  1. Central Banks' Role: Central banks must be proactive and flexible in their monetary policy. The 1930s' gold standard constraint limited the Fed's ability to respond effectively to the crisis. Central banks should be able to adjust interest rates and manage liquidity to stabilize the economy.

  2. Monetary Policy: Monetary policy should focus on both price stability and economic growth. The "real bills" theory's failure during the Depression highlights the need for a more nuanced approach to credit creation and inflation control.

  3. International Cooperation: Economic crises are global, and cooperation among central banks is crucial. The failure to coordinate policies during the Depression exacerbated the crisis. Today, institutions like the International Monetary Fund (IMF) facilitate such cooperation.

  4. Avoiding Deflation: Deflation can deepen economic downturns. The Fed's initial reluctance to ease monetary policy during the 1930s contributed to deflationary pressures. Central banks should be vigilant against deflationary trends.

  5. Regulation and Oversight: The Depression underscored the need for effective regulation and oversight of financial institutions to prevent excessive risk-taking and speculative bubbles.

  6. Leadership and Communication: Central banks must demonstrate strong leadership and communicate their policies clearly to maintain public confidence and avoid panic.

In summary, the Great Depression teaches that central banks must be flexible, cooperative, and forward-thinking in their approach to monetary policy and international economic relations to prevent and mitigate economic crises.

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