U. SANKAR
Futile attempts of men in charge of the four principal central banks to prevent the Great Depression
ORDS OF FINANCE: 1929, The Great Depression, and The Bankers Who Broke the World: Liaquat Ahamed; Pub. by William Heinemann, Random House, 20, Vauxhall Bridge Road, London SW 1V 2SA. £ 20.
Liaquat Ahamed, a professional investment banker, writes the story of World War I and the descent from the roaring boom of the 1920s into the Great Depression by looking over the shoulders of the men in charge of the four principal central banks of the world. The four men are: “at the Bank of England was the neurotic and enigmatic Montagu Norman; at the Banque de France, Emile Moreau, xenophobic and suspicious; at the Reichsbank, the rigid and arrogant but also brilliant and cunning Hjalmar Schacht; and, finally, at the Federal Reserve Bank of New York, Benjamin Strong, whose veneer of energy and drive masked deeply wounded and overburdened man.”
Ahamed says their lives and careers provide a distinctive window to “focus the complex history of the 1920s — the whole sorry and poisonous story of the failed peace, of war and debts and reparations, of hyperinflation, of hard times in Europe and bonanza in America, of the boom and then the ensuing bust.”
Objective
In 1914, the central banks in these countries were privately owned and accountable to the directors who were primarily bankers. Their main objective was to preserve the value of currency. Their currencies were on the gold standard and the amount of currency that could be issued was tied to the quantity of gold reserves. The gold standard brought remarkable prosperity from the 1860s to 1914 because of increases in gold supplies and peace.
During the World War, the governments of Europe had spent $200 billion, about half of their nations’ GDP. The central banks were forced to issue more and more currency notes without gold backing. Money in circulation doubled in Britain, tripled in France, and quadrupled in Germany. The economies of Germany and France had contracted by 30 per cent, Britain by five per cent, and only the United States emerged stronger.
Regarding the German reparations, the initial proposal of Britain was $100 billion, more than 12 times the GDP of Germany in 1914. John Maynard Keynes, in his classic The Economic Consequences of the Peace, underscored the crippling consequences of the large reparations and suggested a sum of $6 billion in the Allies’ own self-interest.
Straightjacket
The author describes the efforts of the four central bankers in currency stabilisation, free flows of capital and resumption of economic growth in the mid-1920s. But soon cracks began to appear and the gold standard proved to be a straightjacket. He narrates the frantic but futile attempts of the central bankers to prevent the world economy from plunging into the downward spiral of the Great Depression.
During the Great Depression (1929-32), “the real GDP in the major economies fell by over by 25 per cent, a quarter of the adult male population was thrown out of work, commodity prices fell by half, consumer prices declined by 30 per cent, wages were cut by a third.” Ahamed maintains that the depression was the direct result of a series of misjudgments by policy makers. He lays the blame on the politicians who presided over the Paris Peace Conference that burdened the world economy with a gigantic overhang of international debts and the four leading central bankers for their decision to take the world back onto the gold standard in the 1920s.
Keynes’ book The General Theory of Employment, Interest and Money published in 1936 revolutionised our understanding of the monetary economy, provided role for government in economic stabilisation and sowed the seeds for the emergence of macroeconomics. He and White of the United States played crucial roles in the creation of the Bretton Woods’s system of the international financial arrangements in 1946.
Lessons
Ahamed draws lessons from the Great Depression for the Mexican crisis in 1994, the South Asian crisis in 1997, the fall of the stock market in 2000, and the global financial meltdown since 2007. He observes that the 1931-33 banking panic that started with the failure of the Bank of United States as well as the financial meltdown in 2007 originated from doubts about the safety of financial intermediaries that had incurred huge losses. The present turmoil is not because the depositors pulled their money out of banks and hoarded currency but because the panicked bankers and investors pulled their money out of financial institutions of all stripes, and all those mysterious “off-balance-sheet special-purpose vehicles” that have sprung up over the past decade.
Compared to the early 1930s, the central banks now have better economic intelligence and access to communication networks and their money supplies are not tied to their gold reserves. There are also norms for banking practices and an international monetary institution for overseeing crises. In many countries, governments’ responses to the meltdown are fast. However, governments are yet to evolve policies for regulating “shadow banking” (non-banking financial system), the phenomenon of what post-Keynesian economist Minsky calls Ponzi finance — like sub-prime mortgage, and complex financial derivative products — and reforming the rating agencies. At the global level, the International Monetary Fund and the World Bank must be restructured to reflect the current economic realities and to enable them to ensure global financial stability.
Ahamed’s story, in the form of biography and not economic history, is interesting and absorbing. This book will be of immense value to bankers, financial managers, and economic policy makers in understanding the causes of economic crises and managing them.
