To the extent that they did espouse a systematic doctrine of monetary policy, it was the “real bills” theory of credit, that we now consider clearly fallacious. This held that provided banks, including the Bank of England, only made loans to finance inventories of goods—such as bales of cotton, or rolls of paper, truckloads of copper wire or steel girders—rather than for financial speculation in stocks and bonds or for long-term investments then no inflation could result. It is simple to see why this is nonsense. In periods of inflation, as the price of goods in inventory keeps rising, this doctrine would call for banks to keep on expanding credit, thus adding further fuel to the inflationary fire. That this doctrine did not lead to monetary disaster was due to the gold standard, which by keeping prices roughly stable, ensured that the “real bills’ doctrine was never given a chance to be applied in an environment of rising prices.
The demands of war finance transformed the Bank. Forced to issue more and more currency notes without gold backing, it became increasingly subordinate to the needs of the UK Treasury. Despite its status as a national institution, the respectable City burghers who ran the Bank had been very careful, over the years, to keep a wary distance from any government. They were clear in their minds that the Bank was not an organ of the state nor did they remotely wish to make it one. An apocryphal story, much circulated in the City before the war, best captures that attitude. A governor was asked by the chancellor of the exchequer to testify before a royal commission. When questioned about the Bank’s reserves, he was only willing to say that they were “very, very considerable.” When pressed to give even an approximate figure, he was supposed to have replied that he would be “very, very reluctant to add to what he said.”
As the stresses of raising money for the war mounted, tensions between the Bank and the government escalated, finally coming to a head in 1917. The governor was then Walter Cunliffe, a tall barrel-chested, John Bull sort of character who sported an imposing walrus mustache, was a renowned big game hunter, and looked more like a gentleman farmer than a City grandee. Over the years, he had become increasingly autocratic and erratic in his judgments and had developed an exaggerated sense of his own importance as governor to the point of insisting that his status required him to deal with the government through the prime minister alone, not even through the chancellor of the exchequer.
In 1917, Cunliffe became infuriated by what he believed was the cavalier way he was being treated by officials at the Treasury, among whom the chief culprit was none other than that brilliantly impertinent young upstart Maynard Keynes. Cunliffe was well known in the City as a man of few words and even more limited intelligence, a bully who acted first and thought later. In a fit of temper, without consulting any of his fellow directors, he dispatched a telegram to the Canadian government, then the North American custodian of Britain’s gold reserves, forbidding it to accept any further instructions from the Treasury in London. The British government came close to the extremely embarrassing position at the height of the World War of not being able to settle the bills from its American suppliers.
Lloyd George, by now prime minister, and justly furious, summoned Cunliffe to 10 Downing Street, and berated the governor, threatening to “take over the Bank.” After some delicate behind-the-scenes negotiations over protocol, the shaken Cunliffe wrote the chancellor of the exchequer as cringing a letter as form would allow, asking him “to accept my unreserved apology for anything I have done to offend you.” Cunliffe, who, because of the war and contrary to all tradition, had been appointed for a second two-year term, was not reappointed again.
DURING THE WAR, as the Bank kept expanding its role as chief underwriter and promoter of government debt, its few senior executives found themselves overwhelmed with work and responsibility. In 1915, the deputy governor, Brian Cockayne, invited Montagu Norman to become his adviser. Though this was to be an informal and unpaid position, Norman, then at a loose end after leaving Brown Shipley, jumped at it. He had originally joined the Court of the Bank in 1907, at the age of thirty-six, but had done so largely for tradition’s sake—it was customary for a partner at Brown Shipley to be on the Court. Indeed for the first few years, he rarely went into the place and showed little interest in its workings. His associations with the institution, however, went far back. He came from two of the most prominent banking families in the City, that special aristocracy from which the Court of the Bank was drawn, and both of his grandfathers had been long-standing directors of some repute in their time.
His paternal grandfather, George Warde Norman, though not a full-time banker—his own inherited fortune derived from timber and real estate—had acquired a large stake in Martins Bank through marriage and was elected a director in 1821. In 1830, at the age of thirty-seven, George Norman retired from full-time business in order to devote himself to his estate in Kent, indulging his love for literature and history; promoting cricket, a family obsession; and enjoying his brood of seven sons. Nevertheless, he remained a dutiful member of the Court for more than fifty years, although in contrast to the typical member, he developed a great interest and some expertise in monetary economics. Like so many Victorian gentlemen of leisure, he published pamphlets—in his case on monetary theory—and became a leader of the move to codify gold standard rules, which were embodied in the Bank Act of 1844. He further broke with tradition at the Bank by categorically refusing to take his turn as deputy governor and governor. Unable to see any reason why he should tear himself away from the many enjoyments of life to inflict upon himself the unnecessary responsibilities and burdens of office, he claimed that his nerves could not cope with the tensions, a curious hint of the troubles that his grandson would face.
Norman’s maternal grandfather, Sir Mark Collet, was very different. A self-made man, he had begun his career as a clerk in a merchant house and moved to New York in 1849. On his return to England two years later, he joined the firm of Brown Shipley, the British arm of the merchant banking house of Brown Brothers of New York and Baltimore, and eventually became senior partner in London. Elected to the Court of the Bank of England in 1866, he dutifully served his turn as governor and was knighted for his services.
Few people were surprised that with this sort of pedigree, Montagu Norman should end up at the Bank. Nevertheless, when he joined in 1915, he had had only a short and not particularly illustrious career as a merchant banker and was not very well known in the City. In his first few weeks, Lord Cunliffe, then governor, was heard to remark, “There goes that queer-looking fish with the ginger beard again. Do you know who he is? I keep seeing him creep about this place like a lost soul with nothing better to do.” Few people could then have predicted that the “fish” would accomplish an extraordinary upward swim through the institution. Nothing in his background suggested that he would be well suited to the work of a central banker. Within three years, however, he was elected deputy governor, and two years later became governor, a post he would eventually hold for an unprecedented twenty-four years.
IN GOVERNMENT HANDS
If Britain was the most responsible of the belligerents, its ally France balanced it out by choosing to be the most feckless. The French government spent a total of $30 billion on its war effort. Few nations resisted paying their taxes more vigorously than the people of France—they seemed to view even the slightest official inquiry as to their financial circumstances as an unjustified intrusion by the state “into the most holy recesses of private life” and an infringement of their fundamental rights as citizens. As a result, at least for the first two years of the war, the government balked at raising taxes, not reversing itself until 1916 when it seemed on the verge of financial collapse. In total, France paid for less than 5 percent of its war expenditures out of higher taxation.
The republic was saved from complete economic disaster only by its government’s ability to tap two sources: first, the notoriously thrifty French middle classes, which bought $15 billion worth of government bonds; and second, foreign government
s, specifically those of Britain and America, which, seeing France bear the brunt of the human cost of the war, lent a total of $10 billion. This still left a substantial gap, which was filled by printing money. While currency in circulation doubled in Britain, in France it tripled.
Drawing on the central bank for money was a much easier process in France than in Britain—in part because the governor of the Banque de France was by tradition not a banker but a high civil servant appointed by the state. Indeed, as far back as 1911 the minister of finance, thinking ahead, had prearranged a line of credit from the Banque to be drawn upon in the event of war. There was a certain irony in this. The Banque de France, like the Bank of England, had been founded in the middle of a war, but unlike its older cousin it had been set up not so much to raise money but to bring order to a chaotic monetary situation.
France in 1799 faced a pressing shortage of currency. Ten years of Revolutionary turmoil had taken their toll. Silver and gold had fled the country, and the failed experiment of the Revolutionary government with the assignats had destroyed any residual confidence in paper money not backed by gold. Two financiers, the Swiss banker Jean-Frédéric Perregaux and the sonorously sounding Jean-Barthélémy Le Couteulx de Canteleu, a rich merchant from Rouen, received the blessings of the first consul of the republic, Napoléon Bonaparte, to create a new bank that would issue currency backed by gold and have a capital of 30 million francs, equivalent to $6 million.11
The Banque opened its doors on January 18, 1800, or according to the calendar of the Revolution then in force, on the 28th day of Nivose, the month of snow, in the year VIII. The bulk of its capital was raised from merchant and banking families, many of them Protestants of Swiss origin. But the glittering arriviste circles surrounding the first consul were also keen to buy into a venture that promised much profit. Napoléon himself took thirty shares, each valued at 1,000 francs; Louis-Antoine Fauvelet de Bourrienne, his secretary, who would later be dismissed for corruption and betray Napoléon by rallying to Louis XVIII, took five; Joachim Murat, Napoleon’s brother-in-law and a future king of Naples, nine; Hortense de Beauharnais, Napoleon’s stepdaughter, his sister-in-law-to-be, and a future queen of Holland, five; Napoléon’s older brother Joseph, a future king of Spain, just one. To encourage investors, the Banque was made as independent of the government as the Bank of England and, in 1803, was granted a monopoly over note issuance in Paris.
In 1805, immediately following the naval disaster at Trafalgar and just as Napoléon was launching his latest campaign against the Austro-Russian alliance, a panic among the merchants of Paris precipitated a run on the still infant Banque and almost forced it into liquidation. It was saved when news arrived in the capital of Napoléon’s brilliant victory at Austerlitz. While confidence was quickly reestablished in the new Banque, lubricated by large indemnity from the Austrians, Napoléon remained enraged by the feeble-heartedness of his bankers.
On his return from Austria, he summoned his council of ministers and, in one of his imperial tantrums, fired his minister of finance. To the Banque’s three-man management committee he offered the choice between prison or a fine of 87 million francs. They chose the fine. Determined never again to be held hostage by moneymen, Napoleon changed the Banque’s statutes so that henceforth the governor and the two deputy governors would be appointed directly by the government, which at that time meant Napoléon himself. He declared at the time, “The Banque does not belong only to its shareholders, but also to the state. . . . I want the Banque to be sufficiently in government hands without being too much so.”
For Émile MOREAU the war meant a continuation of his exile at the head of the Banque d’Algérie. In 1914, after Henriette Caillaux’s acquittal, he must have secretly harbored some hope of returning to the Ministry of Finance on his mentor Caillaux’s coattails. But this was quickly squashed with the outbreak of war, for Caillaux, always viewed as soft on Germany, was not invited into the war government.
Indeed, Caillaux made things even worse for himself during the war. With his characteristic bad judgment, he became embroiled in 1916 with a shady bunch of characters who were trying to negotiate a back-channel settlement with Germany. One of these, Paul Bolo-Pasha, a confidence trickster in the joint service of the Egyptian khedive and German intelligence, was arrested in 1917, tried, and shot for espionage. In the ensuing spy mania that seethed through France, Caillaux himself was accused of treason. Deprived of his parliamentary immunity, he was jailed in early 1918. He would finally be brought to trial before the Senate, sitting as a high court of justice, in 1920. Though acquitted of treason, a capital offense, he would be found guilty of “imprudent conversations” with the enemy and condemned to three years imprisonment; five years deprivation of civil rights; and a peculiarly French punishment, interdiction de séjour—banishment from Paris, a somewhat archaic penalty usually reserved for drug addicts, white slavers, and thugs.
Watching the tragic, almost comical, antics of his old leader, there must have been times when Moreau felt that he had been cursed in his choice of mentors. Though the Banque d’Algérie was called upon to play a modest role in financing the war effort—it supplied some $200 million in loans to the government—this was small compared to the $4 billion provided by its larger and more prestigious sibling, the Banque de France. By 1919, Moreau had almost reconciled himself to serving out his time until retirement in the backwaters of the Banque d’Algérie.
OBEDIENCE AND SUBORDINATION
Germany’s strategy for paying for its military effort was dominated by the absolute conviction of the men around the kaiser that the war would be short, that the Reich would prevail, and that it would then present the bill to the vanquished. The German government raised barely 10 percent of the $47 billion it spent on the war from taxes. And because Germany lacked Britain’s sophisticated financial market, France’s great reserve army of middle-class savers, or a rich ally across the ocean willing to lend it vast amounts of money, it had to resort to an unusually high degree of inflationary finance. Whereas during the war, money in circulation doubled in Britain and tripled in France, in Germany it went up fourfold.
The architects of this disastrous policy were paradoxically two of the most competent financial officials in all Europe: Karl Helfferich, the secretary of the Reich Treasury Office, the imperial German equivalent of minister of finance, and Rudolph von Havenstein, the aristocratic head of the Reichsbank. Helfferich, the most famous economist in Germany, was a professor who before the war had written one of the best works anywhere on monetary economics, Das Geld, which had been through six editions and had been translated into numerous languages, including Japanese.
Von Havenstein, a lawyer by training, did not have the same background but was universally acknowledged to be one of the most dedicated, upstanding, and loyal officials in the entire Reich. With his piercing eyes, long and luxuriant, well-waxed whiskers, and pointed beard, he looked like the impresario of a Victorian music hall. In fact, like his two predecessors as president of the Reichsbank, he was a typical product of the higher reaches of the imperial civil service. Born into the Prussian gentry in 1857, of a landowning family from Brandenburg, he studied law and became a county court judge. In 1890, he joined the Prussian Finance Ministry and was appointed president of the Reichsbank in 1908.
Service to the kaiser was the cornerstone of Wilhelmine Germany and both men allowed themselves to be blinded by their loyalty to the emperor, all the easier in Hellferich’s case because he was an extreme right-wing nationalist and a fervent believer in the glorious destiny of the German people and the historic mission of their leader.
Von Havenstein was a civil servant of the old school and believed strongly in the paramount virtue of duty. As one banker wrote, “Obedience and subordination [were] part of his flesh and blood.” While the Reichsbank was legally owned by private shareholders, Von Havenstein and all his top officials were responsible to a board comprised of politicians: the imperial chancellor and four member
s representing the federal German states. The structure had been put in place by the founder of the Reichsbank, Count Otto von Bismarck, a man who above all understood power. Aside from the accumulation of an enormous personal fortune, Bismarck showed little interest in economics. However, when the Reichsbank was being formed in 1871, his own private banker and confidant, Gershon Bleichröder, warned him that there would be occasions when political considerations would have to override purely economic judgments and at such times too independent a central bank would be a nuisance.
Thus, even though the German money supply ballooned during the war, and prices more than quadrupled—the inflation rate exceeded 40 percent a year—Von Havenstein became something of a national hero. He was showered with honors and decorations, immensely popular with the public, and the kaiser even affectionately nicknamed him with the engaging pun der Geld Marschall, the “Money General.”
DESPITE His belief that the war had been a mistake, Hjalmar Schacht threw himself into the war effort as energetically as most citizens of imperial Germany. He was severely shortsighted and thus exempted from military service. Convinced like everyone else that German victory was assured, only three weeks after the outbreak he was busy developing a plan for extracting reparations from France. It was a sign of how far off the mark even the most astute observers were to be about the costs of the war that Schacht came up with a working figure of $10 billion. Though ten times the amount France had paid after the Franco-Prussian war of 1870, this would turn out to be only a fifth of the eventual total costs of Germany’s war budget.
In October 1914, as the Western Front sank into stalemate, Schacht was offered a job on the staff of the Banking Commission overseeing the finances of occupied Belgium, which was run by the military administration. He soon discovered that he was temperamentally ill suited to the army. He found the rigid hierarchy, the narrowness of the military mind, and the self-importance of the professional officer caste oppressive.
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