Lords of Finance

by Liaquat Ahamed

  THE THREE-MONTH interlude in which Roosevelt spent his breakfast hours managing the world’s gold price represents one of the more bizarre episodes in the history of currency policy. It undermined the dignity of the office of president and diminished respect for him abroad. Even Maynard Keynes, who was in favor of managed currencies, dismissed the exercise as “the gold standard on the booze.” But at least the dollar staggered in the right direction.

  By the end of the year, Roosevelt had begun to tire of the game; and in January 1934 he agreed to stabilize gold at $35 to the ounce. The dollar had now been devalued by over 40 percent. And while the high priests of Wall Street had prophesied chaos, Roosevelt’s instincts were vindicated. Devaluation changed the whole dynamic of the economy.

  This worked in two ways. First, as Warren had predicted, the fall in the dollar did get prices moving upward—by roughly 10 percent per annum. Once prices began rising, the burden of interest payments and the real cost of money were automatically reduced, making businesses more willing to borrow and consumers more ready to spend. By thus shaking the country out of its funk, the dollar move reversed expectations out of their vicious and self-fulfilling downward spiral into a virtuous circle pointing the other way. For as the economy developed momentum, the recovery fed on itself.

  Devaluation not only changed the dynamic of spending, it also supplied the fuel to power those expenditures. In the four years after 1933, the value of gold held by the Fed almost tripled, to $12 billion, in part due to the higher value of the existing stock of gold, in part to new inflows of gold from abroad—over $5 billion of additional bullion arrived in the country. Some of this was drawn from other central banks. But most came from the ground, as the higher price spurred the mining industry—worldwide gold production added almost $1 billion a year to world reserves. A high fraction of this additional liquidity went into building up the reserves of banks, which, scarred by the years from 1931 to 1933, took a long time to regain their nerve. Nevertheless, there was enough money flooding through the system that it percolated though to the rest of the economy.

  As a consequence, during Roosevelt’s first term, U.S. industrial production doubled and GDP expanded by 40 percent—the largest peacetime increase in economic activity in a presidential term. The expansion did not occur in a straight line and was not uniform. Confidence was still fragile and recovery thus subject to fits and starts. Investment did not rebound as much as consumption—for many of the New Deal policies to support wages hurt both profits and general business confidence. The economic indicator, which took the longest to recover, was employment. Even while production doubled in four years, the number of unemployed remained stubbornly high—by 1936, there were still ten million men without jobs. Again, many of Roosevelt’s measures to boost prices or wages by government fiat raised the cost of hiring workers and hampered recovery. Because the contraction had gone so deep, it still took ten years for the economy to regain its old trend.

  While the rebound was powered by an abundance of money at low interest rates, the Fed found itself ejected from the driving seat. Having made such a mess during the collapse, it had lost whatever prestige it once possessed.

  In 1935, Congress passed a banking act designed to reform the Federal Reserve. Authority for all major decisions was now centralized in a restructured Board of Governors. The regional reserve banks were stripped of much of their powers and responsibility for open market operations was now vested in a new committee of twelve, comprising the seven governors and a rotating group of five regional bank heads, renamed presidents. The secretary of the treasury and the comptroller of the currency were removed from the Board, giving it theoretically even greater independence from an administration. While these measures improved the efficiency of the Fed’s decision-making machinery, they came ironically enough at a time when there were few decisions to take. In 1934, Marriner Eccles, a Mormon banker from Utah, had taken over as the head of the Federal Reserve Board. Scarred by the experiences of running a bank during the Great Depression, Eccles held to the view that with unemployment still high and confidence still weak, the Fed’s prime task should be to keep interest rates as low as possible.

  Though the New York Fed lost much of its clout and was now overshadowed by the Board in Washington, George Harrison soldiered on as its president for another eight years. In 1941, he left to become the chief executive the New York Life Insurance Company. During World War II, he was asked by his old friend Henry Stimson, now secretary of war, to become his special assistant for matters related to the Manhattan Project. He served on the Interim Committee, a secret high-level group formed in May 1945 to examine problems related to the creation of the atomic bomb and to advise on its use against Japan. On July 16, after the successful detonation of the world’s first nuclear device in the New Mexico desert, it was Harrison who was the author of the now-famous cable to Secretary Stimson and President Truman at Potsdam: “Operated on this morning. Diagnosis is not complete but results seem satisfactory and already exceed expectations.”

  After the war he returned to the New York Life Company. Like so many central bankers, he married late—at the age of fifty-three—to Mrs. Alice Grayson, widow of his old friend Admiral Grayson, who had been Woodrow Wilson’s doctor and accompanied him to the Paris Peace Conference. Harrison died in 1958 at the age of seventy-one.

  22. THE CARAVANS MOVE ON

  1933-44

  If a man will begin with certainties, he shall end in

  doubts; but if he will be content to begin with

  doubts, he shall end in certainties.

  —FRANCIS BACON

  BREAKING with the dead hand of the gold standard was the key to economic revival. Britain did so in 1931 and began its recovery that year. The United States followed in March 1933 and that proved to be the low point in its depression. France hung on to its link with gold for the longest. In 1935, Clément Moret was fired as governor of the Banque de France for resisting government measures to utilize its gold reserves to expand credit. Only in the following year did France finally abandon the gold standard. It was thus the last of the major economies to emerge from depression.

  The exception to this pattern was Germany. After the summer 1931 crisis, it defaulted on reparations and introduced exchange controls. But it never officially left the gold standard. Still obsessed by an archaic fear of inflation, a carryover from 1923, and despite having no gold reserves, Germany decided to act as if it were still on gold, nailing itself to a sort of shadow standard and thereby forgoing the benefits of a cheap currency. x When Britain devalued the pound in September, German foreign trade completely collapsed.

  Schacht with Adolf Hitler

  FIGURE 8

  The continued economic slide in 1932 precipitated even more political turmoil. In May 1932, Brüning was turned out of office by a right-wing cabal. The following month, France and Britain, finally recognizing that it was impossible to squeeze any money out of Germany in the current environment, formally agreed to forgive all reparations. In the fourteen years since these had first been imposed, the Allies, who had once demanded $32 billion, and had settled on $12 billion, had succeeded in collecting a grand total of $4 billion from their old enemy.

  Brüning was replaced by Franz von Papen, an ex-cavalry officer from an impoverished aristocratic family who had married into wealth and whose only talent was his horsemanship. In August, he called new elections, in which the Nazis won 230 seats, more than double their previous representation, making them the largest party in the Reichstag. But President Von Hindenburg was not yet ready to invite the “Bohemian Corporal,” as he referred to Hitler, to become chancellor.

  In 1931, Hjalmar Schacht had been interviewed by the American journalist Dorothy Thompson. “If Hitler comes to power, the Nazis can’t run the country financially, economically. Who will run it?” she asked. “I will,” replied Schacht. “The Nazis cannot rule, but I can and will rule through them.” It had become clear to him even then that it was
only a matter of time before Hitler would become chancellor.

  Schacht would later claim that he never allowed himself to fall under Hitler’s spell and that because Hitler needed him, he was able to maintain a certain degree of independence. This is not apparent in a creepy letter he wrote to Hitler after the August elections, congratulating him on his victory and regretting that he was not already chancellor: “Your movement is carried internally by so strong a truth and necessity that victory in one form or another cannot elude you for long. During the time of the rise of your movement you did not let yourself be led astray by false gods. . . . If you remain the man that you are the success cannot elude you for long.” But the main purpose of the letter was to urge Hitler to avoid becoming entangled in economic ideology—for Schacht realized that if he wanted to run Nazi economic policy, he would have to counteract some of the anticapitalist sloganeering of the party’s left. At this stage he believed that its virulently anti-Semitic ragings were restricted to a lunatic fringe. He ended by saluting Hitler “with a vigorous Heil.”

  Over the next few months, as the Nazis maneuvered to undermine successive governments in the Reichstag, Schacht became a prominent supporter of the movement and a major fund-raiser for the party. In November, he was one of twenty-tour industrialists, including the steel magnate Fritz Thyssen and the arms manufacturer Gustav Krupp, who signed a public letter urging Von Hindenburg to appoint Hitler chancellor. In an interview carried in newspapers around the world, Schacht declared that Hitler was “the only man fit for the Chancellorship.” Finally, in January 1933, the president bowed to necessity and appointed the “Bohemian corporal” as chancellor.

  Two months later, on March 16, 1933, Schacht was back at the Reichsbank, after a three-year hiatus. Hitler, who showed little interest in economics, had two overriding objectives—to combat unemployment and to find the money to rearm. The details of how to achieve these goals he left to Schacht, who in those early years was given almost complete control over economic policy—in addition to being president of the Reichsbank, he became minister of the economy in August 1934. Hitler would later confess that he thought Schacht “a man of quite astonishing ability . . . unsurpassed in the art of getting the better of the other party. But it was just his consummate skill in swindling other people which made him indispensable at the time.”

  Displaying the inventive genius that distinguished him as the most creative central banker of his era, immediately upon taking office, Schacht threw the whole baggage of orthodox economics overboard. He embarked on a massive program of public works financed by borrowing from the central bank and printing money. It was a remarkable experiment in what would come to be known as Keynesian economics even before Maynard Keynes had fully elaborated his ideas. Over the next few years, as the German economy experienced an enormous injection of purchasing power, it underwent a remarkable rebound. Unemployment fell from 6 million at the end of 1932 to 1.5 million four years later. Industrial production doubled over the same period. Schacht also renegotiated the terms of Germany’s massive foreign debts, ruthlessly playing off its creditors against one other, particularly the British and the Americans.

  The recovery was not quite the miracle that Nazi propagandists made everyone believe it was. Though there were some highly visible achievements—the creation of millions of jobs, the construction of the famed autobahns—the boom remained stunted and lopsided. Much of the increase in production came in arms-related industries, such as autos, chemicals, steel, and aircraft, while such everyday consumer items as clothing, shoes, and furniture stagnated. As a consequence, the standard of living of ordinary Germans rose hardly at all. They had to content themselves with a drab existence of shoddy goods made of ersatz materials—sugar from sawdust, flour made with potato meal, gasoline distilled from wood, margarine from coal, and clothes made out of chemical fibers.

  While other European countries let their currencies fall against gold, Schacht, motivated by a combination of concern for prestige and fear of inflation, refused to break officially from gold and devalue the Reichsmark. German goods were overpriced on the world markets and its exports stagnated. In order to cope with the pressures created by this bloated exchange rate, an elaborate system of import controls was put in place and foreign trade was largely based on barter. Under this “Schachtian” system, Germany was reoriented from an open economy integrated with the West to a closed autarkic economy connected to Eastern Europe and the Balkans, a precursor of the inefficient Soviet trade system of the 1950s and 1960s.

  Behind the gleaming achievements, therefore—the autobahns, the Volkswagen, the Junker bombers, and the Messerschmitt fighter planes—the Nazi economy was a rickety machine plagued by shortages and relying heavily on rationing to allocate scarce consumer goods.

  Schacht, once such a strong believer in an open Germany integrated with the West, justified himself by arguing that he had been driven to the policy of hunkering down and looking inward by a deranged international system: “The whole modern world is crazy. The system of closed national boundaries is suicidal . . . everybody here is crazy. And so am I. Five years ago I would have said it would be impossible to make me so crazy. But I am compelled to be crazy.”

  When he first came to power, Schacht used to say that he would be willing to make a pact with the devil in order to restore German economic strength. By the late 1930s, he began to fear he had done just that. He never joined the Nazi Party nor did he become a member of Hitler’s inner circle. But as the regime’s abuse of power mounted, he found himself increasingly at odds with the direction of those who ran it. He had always kept his distance from the other Nazi bigwigs—Himmler, Göring, Goebbels— often treating them with contempt and relying on Hitler to protect him. Now he came into open conflict with them, especially over corruption.

  On the Berlin cocktail circuit the rumor was that Schacht had the banknotes issued to the ministries controlled by Göring, Goebbels, and Himmler marked, thus enabling him to track how much ended up in foreign accounts. He was increasingly heard referring to the Nazis as a bunch of “criminals” and “gangsters,” and even calling Hitler a “cheat and a crook.”

  Schacht was not above exploiting the popular irrational hatred and suspicion of Jews by peppering his speeches with anti-Semitic remarks. Nevertheless, he fought against many of the regime’s more extreme policies against Jews not so much on moral grounds as out of the pragmatic fear that they were harming the economy. In 1938, he was one of the architects of a plan to allow four hundred thousand German Jews to emigrate over the coming three-year period, their assets to be expropriated and placed in a trust as collateral for bonds that were to be sold to rich Jews outside Germany. The money so raised was to be used to resettle German Jews and to subsidize German exports—a macabre extortionary scheme in effect to ransom these desperate people. It placed the international Jewish community in a quandary—whether to agree to a plan that implicitly sanctioned seizing Jewish property in Germany and Austria, channeling money to the Nazi regime and setting a precedent for other blackmail elsewhere in Europe, but which had the potential to save lives. Schacht would later defend himself by claiming that his scheme could have saved hundreds of thousands of lives—he seemed conspicuously unaware of the moral dilemmas it posed. In any case, it died for lack of money and of countries willing to accept the refugees.

  By 1937, the strains of helter-skelter rearmament and deficit financing began to tell. Shortages began to bite. Schacht tried to push Hitler to go slow on the arms buildup and ease up on consumer austerity. In November 1937, after falling out with Hermann Göring, he was fired by Hitler as minister of the economy and replaced by Walter Funk, an alcoholic homosexual. Two years later, when Schacht tried to resist further central bank financing of the ever-growing budget deficit, he was also removed from the Reichsbank, again to be replaced by Funk. Though Hitler gave him the titular position of minister without portfolio, this was largely window dressing for foreigners—Schacht was still respected by th
e international banking community—and he was now for all intents and purposes a private citizen.

  In the years immediately before the war, Schacht took a leading part in several of the conspiracies by conservative politicians and businessmen to overthrow Hitler. They involved trying to induce members of the army high command to stage a coup by convincing them that under the Nazis, Germany would be plunged into a war for which it was ill prepared. The first took place in 1938 when Hitler tried to take over Czechoslovakia. Plans for that pustch were aborted at the last minute when British prime minister Neville Chamberlain and French premier Édouard Daladier backed away from the brink by making concessions at Munich. A second occurred in late 1939 in the weeks before the invasion of Poland. This final conspiracy was overtaken by events before the plotters could act.

  After war broke out, Schacht kept a low profile, retiring to his estate in Gühlen away from the intrigue and paranoia of Berlin. It was ironically a time of great personal happiness. His first wife died in 1940. They had become estranged over time and lived apart. The following year, at the age of sixty-four, he married a woman thirty years his junior, a museum curator whom he had met at a fashionable Munich nightclub. Over the next three years, they had two children, both girls.