18.3.09

A RAPID CONCATENATION OF TROUBLES. U. S. investors stop supplying capital to a country and a region goes into recession. Stock prices revert to their more traditional multiple of earnings. Financial intermediaries have suspect balance sheets. Governments borrow heavily. These events occur within the span of a year or two, rather than over a decade. The events in question are what we now know as The Great Depression and Liaquat Ahamed's Lords of Finance: The Bankers who Broke the World analyzes them and places them in historical context. Book Review No. 11 concludes that the book gives reason for cautious optimism. Unlike today's central bankers, the lords (England's Montagu Norman, France's Emile Moreau, Germany's Hjalmar Schacht, and Federal Reserve chairman Benjamin Strong) were constrained by a gold standard worked out when the British Empire was the leading financial power but imbalanced by the gold reserves accumulated by the United States during the Great War, and managing capital markets burdened by large public borrowing to pay for that war. The European powers borrowed integer multiples of their annual national income to finance that war, from each other and from the United States, and demanded large reparation payments from Germany. That the countries didn't turn on the printing presses earlier becomes one of the stories of the book. That the rigidities of the gold standard led monetary authorities to consider new standards for changing exchange rates is another. That policy makers learned by their mistakes, particularly in the 1928-1933 era, offers grounds for cautious optimism.

The central bankers themselves are an interesting lot, often people not born to the ruling circles, sometimes middle-class strivers who make tremendous personal sacrifices to achieve their positions (central banking being neither glamorous nor for the weak of mind). Their private foibles and troubles add richness to the story.

If there is a star of the story, it is John Maynard Keynes, who accurately understood the errors of the Versailles treaty and of the gold standard, particularly one based on the pre-war conversion terms. An article he wrote for a British paper resonates today See pages 229-230.
We should run the risk of having to curtail ... credit to our industries merely because an investment boom in Wall Street had gone too far, or because of a sudden change in fashion amongst Americans towards foreign bond issues, or because banks in the Middle West had got tied up with their farmers or because of the horrid fact that every American had ten motor-cars and a wireless set in every room of every house had become known to manufacturers of these articles.
Mr Ahamed suggests that the depression that began, long before there were ten cars in every garage and wireless in every room, was exacerbated by the ineptitude of the successors to Mr Norman and in particular Mr Strong.

(Cross-posted to 50 Book Challenge.)

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