Grand Pursuit

by Sylvia Nasar

  Keynes and Fisher became economic oracles. They prospered financially. More important, they created new intellectual wealth. The violent inflations and deflations that followed World War I convinced them that free markets and democracy could not long survive such pathologies and focused their minds on systemic causes. Like the doctor in Molière’s Le Malade Imaginaire, they shifted their attention from individual parts of the economic body to its circulatory system. They concluded that inflation and deflation, seemingly polar opposites, were symptoms of the same underlying disease, and that the system of money and credit creation was both its source and its transmission mechanism.

  Solving the immediate problem of how to revive the interlocking parts of the world economy, some in extremis, required a new framework. Fisher and Keynes nourished the hope that the violent booms and depressions could be avoided. They no longer believed, as Alfred Marshall had, that booms and depressions resulted from random external shocks or, as Karl Marx had, that they were intrinsic to the market economy. Instead of acts of nature, extreme gyrations were man-made disasters capable of being averted. Fisher, Keynes, and Hayek searched for instruments of mastery, confident that these existed and could be made to work—even if the Englishman and the American were prepared to trust the discretion of civil servants while the Austrian, product of a more tragic national history, insisted that governments be bound by rules. Only Schumpeter could be described as fatalistic, as much because of temperament and personal tragedy as because of intellectual conviction.

  • • •

  When Schumpeter was driven from office in the fall of 1919, Austria’s fiscal crisis was entering an acute stage. Faced with a ballooning deficit and too fearful of public unrest to impose austerity measures, the cash-strapped government of Karl Renner printed more and more paper money to pay its bills. Ludwig von Mises, the president of the Chamber of Commerce, described the “heavy drone” of the central bank’s printing presses: “They ran incessantly, day and night . . . [Meanwhile] a large number of industrial enterprises were idle; others were working part time; only the printing presses stamping out notes were operating at full speed.”2 The more kronen the government issued, the less one krone could buy. Vienna’s police chief complained that “every issue reduces the value of the krone.”3 The effect on the krone’s exchange value was immediate, and because Austria imported so much of her daily requirements, the plunging exchange rate sent domestic prices spiraling upward. Ironically, the Social Democrats initially welcomed inflation as an economic stimulant, not suspecting how soon it would end in prostration—and political ruin—like any other episode of mania.

  Initially, easy credit and rising prices seemed to jolt the paralyzed economy back to some semblance of life. Investment, exports, and employment perked up as inflation slashed the real cost of borrowing and the falling krone let Austrian exporters undercut foreign rivals. But eventually Austria’s trading partners began imposing tariffs on her exports, businesses had difficulty restocking inventories, and unemployment began to swell again.

  Meanwhile, inflation went from a trot to a canter to a wild gallop. Despite constant renegotiation of union contracts, a worker who had earned 50 kronen a week before the war earned about 400 kronen at the end of 1919. But his new salary let him buy just one-quarter as much food, coal, or clothing as his old one. Instead of an eightfold pay raise, he had actually suffered a 75 percent pay cut. Within a year he would need more than eight weeks’ pay to buy a cheap suit and a pair of boots.4 Civil servants and pensioners found that their weekly incomes afforded them no more than a couple of eggs or loaves of bread. That was just the beginning. At one point, Freud, who was considering moving to Berlin, complained, “One can no longer live here and foreigners needing analysis no longer want to come.”5 By October 1921, prices were rising by more than 50 percent every month on average, marking the beginning of a hyperinflation. By October 1922, the price level was two hundred times higher than a year earlier.

  Inflation wiped out the entire savings of the middle class and undermined its faith in democratic government argues historian Niall Ferguson. “All of us have lost 19/20ths of what we possessed in cash,” Freud wrote to a friend.6 Worthless bank notes, like ersatz food and paper suits, created a universal feeling of being cheated. In Stefan Zweig’s “The Invisible Collection,” a blind art connoisseur believes that his portfolio of old master drawings is intact. In reality, his family has bartered them away and substituted blank sheets of vellum for the missing works. Anna Eisenmenger, the diarist, wrote of feeling betrayed as she surveyed her “remaining 1,000 kronen notes; lying by the side of my food [ration] cards in the writing table drawer . . . Will not they perhaps share the fate of the unredeemed food cards, if the State fails to keep the promise made in the inscription on every note?”7 As confidence in the krone collapsed, daily commerce reverted to barter. Many peasants and shopkeepers refused to accept cash. For the middle classes, it meant trading a piano for a sack of flour, fifty prewar cigars for four pounds of pork and ten pounds of lard, a gold watch chain or, in Freud’s case, a journal article for a few sacks of potatoes.

  Until the shelves were bare, one could buy anything in a Viennese shop, including its entire contents, for a few pounds or dollars. La Peine des Hommes: Les Chercheurs D’Or, a novel published in 1920 by the French journalist Pierre Hamp, portrays an inner city populated by carpetbaggers who flock to Vienna like vultures. Salzbach, the hero, accuses them of turning misery into gold.8 Bigger bargains were found in Austria’s farmland, mines, railways, ships, power plants, factories, and banks. As the krone depreciated, these too became available at fire sale prices if the buyer paid in pounds, dollars, or another “hard” currency. Foreign takeovers stoked popular anger, one reason that the Kola affair involving Fiat’s purchase of Alpine Montan, the iron concern, continued to dog Schumpeter long after he left office.

  While war veterans hung around outside dozens of restaurants inside the Ring waiting for scraps, a new class of millionaires drank champagne and dined on delicacies “equal in quality and quantity to that obtained in London.”9 The stark contrast between the newly rich and the newly poor that had disgusted the young Adolf Hitler before the war grew more extreme. Panhandlers, beggars, and refugees seemed to be everywhere. Popular resentment focused on black marketeers, war profiteers, foreigners, and especially Jews. Every surge in food prices was followed by demonstrations against the rising cost of living and outbursts of violence. In December 1921, a huge crowd smashed shop windows, attacked hotels, and looted food shops. One visitor to Vienna wrote to his wife that “hand in hand with the exasperation caused by the continual rise in prices goes a feeling of intense resentment and hate against all those who have made money out of Austria’s misfortune, the ‘Schiebers,’ speculators on the exchange market, and their like ‘who are mostly Jews.’ ”10

  Inflation turned the old Vienna into a funhouse of inverted, topsy-turvy values. In The Joyless Street, Georg Pabst’s 1925 film starring Greta Garbo, senior civil servants huddle in dark, unheated apartments, neighbors spy on one another, housewives break the law, girls from good homes become prostitutes, and sober citizens turn into manic stock speculators. Gilt-edged stock certificates became the inflation hedge of choice. People who had never invested in anything but government bonds suddenly poured what was left of their cash into the stock market, where huge profits were being made.

  In her diary, Anna Eisenmenger reports a conversation with her bank manager that captures the helplessness of the middle class in the face of the speculative fever that was attacking the whole population:

  “If you had bought Swiss francs when I suggested, you would not now have lost three-fourths of your fortune.”

  “Lost?” I exclaimed in horror. “Why, don’t you think the krone will recover again?”

  “Recover?” He said with a laugh . . . Our krone will go to the devil, that’s certain.”

  “Come into my room for a moment . . .” There he began to explain to me t
hat the monarchy was compelled to issue war loans and that the subscription to these loans was often compulsory. This was done because the State had already used up its gold reserves and had no money left for carrying on the War. With the money from the war loans the War was continued, but there was practically no cover for the notes at present in circulation.

  “Just test the promise made on this 20 kronen note and try to get, say, 20 silver kronen in exchange for it,” he said, holding out a 20 kronen note . . . “Now you will understand me when I tell you that at the present time it is well to possess a house or [land] or shares in an industry or mine or something else of the sort, but not to possess any money, at least no Austrian or German money. Do you understand what I mean?”

  “Yes, but mine are government securities. Surely there can’t be anything safer than that.”

  “But, my dear lady, where is the State which guaranteed those Securities to you? It is dead.”11

  The conversation ended with the bank manager advising Madame Eisenmenger to put her money in stocks. Like countless other Viennese, she did.

  • • •

  Although his political career was apparently over and he had been forced to return to his university post in Graz, Schumpeter still had friends in high places. To compensate him for his ignominious sacking, conservatives in parliament awarded him a banking charter the following year. The charter was his to sell, use, or sock away. Since there were fewer than two dozen investment banks in Vienna and many banking partnerships were desperate to raise capital by selling shares to the public, a license to start a bank had many potential takers. Parliament’s gift to Schumpeter proved a golden parachute of considerable value.

  On July 23, 1921, Schumpeter was elected president of Vienna’s oldest investment bank, M. L. Biedermann, on the day it went public. He was twenty-nine years old. In return for the use of the charter and his signature on banknotes and such, Schumpeter got a magnificent office, an annual salary of 100,000 kronen (about $250,000 in today’s dollars), and enough stock to make him the bank’s second-largest shareholder. The biggest perk was a practically unlimited line of credit to invest on his account.

  His timing was perfect. The League of Nations was finally cobbling together a rescue package for Austria that bore a striking resemblance to the stillborn Schumpeter plan of 1919. In return for an emergency loan, the government promised to embrace fiscal and monetary discipline by creating a new central bank that would be barred from financing the government’s deficits by buying Treasury bills, by balancing its budget by firing a hundred thousand civil servants and closing tax loopholes, and, when Austria’s foreign debt had shrunk to a specified level, by returning to the gold standard. The rumor of the impending deal and the simultaneous announcement that the Allied Reparation Commission was renouncing claims on Austria sufficed to halt the krone’s decline and brought inflation down from 1,000 percent to 20 percent even before the protocols were signed in August.12

  The speculative fever did not abate, but instead shifted to gilt-edged stocks. As businesses issued shares instead of taking out loans at higher real interest rates, banks gobbled up the new stock certificates. Soon banks were the largest shareholders in Austrian business. According to the historian C. A. Macartney,

  Austrian banks—a very few conservative concerns of established reputation always excepted—did not confine their investments by considerations of safety, things went on just as merrily on these shares as they had on the exchange. Industry itself, including the most reputable, had become speculative. It passed largely into the hands of the banks, its shares were bandied about and used for the most improbable purposes.13

  As expected, Schumpeter left the banking to Biedermann’s capable longtime chief and became, in effect, a money manager and venture capitalist. He promptly took large stakes in several enterprises, in some cases with a partner who was an acquaintance from the Theresianum. Within months, he was a director of the Kauffman Bank, a porcelain works, and a chemical subsidiary of a German multinational.14

  The frenzy of deal making, buying, and selling was intoxicating. Schumpeter may have dressed like a bank president, but, as the Viennese press observed snidely, his lifestyle was as extravagant as a lord’s. He still owed large personal debts and even larger tax arrears. He had given up his hotel suite and his half of the Palais, but he threw lavish dinners at his apartment and spent prodigiously, whether on his mistresses, horses, or clothes. He was as careless of his reputation as he was of his money. In response to a business associate’s warning about appearing in public with prostitutes, “he rode up and down . . . a main boulevard in the inner city . . . with an attractive blond prostitute on one knee and a brunette on the other.”15

  At the beginning of 1924, Schumpeter considered his financial affairs to be “perfectly in order,”16 his Biedermann line of credit being covered by gilt-edged securities. Then came the spectacular collapse of the Vienna stock exchange on May 9, 1924. Between breakfast and dinner, three-fourths of the value of the “highly marketable securities” that constituted Schumpeter’s personal collateral had disappeared in a puff of smoke.17 In the frantic days that followed, he was forced to dump the best of his remaining stocks into a falling market. Thanks to a wrong-way bet against the French franc, the Biedermann bank had sustained huge foreign-currency losses. To raise cash, the bank’s directors, Schumpeter included, had to sell large numbers of Biedermann shares to a subsidiary of the Bank of England. Over the summer, several of his companies failed, forcing him as a director to compensate their shareholders. His Theresianum partner turned out to be, if not a crook, then guilty of shady dealings, and Schumpeter was named in several lawsuits as well as a criminal inquiry that dragged on for years.

  The combination of personal insolvency and an unsavory business associate was too much for Biedermann’s British investors, who insisted that Schumpeter resign. By the time he did so in September 1924, amid accusations in the media that he had used his Biedermann connections to do favors for a government minister, nothing was left of his millions. The bank directors granted Schumpeter a severance equal to a year’s salary, but his debts were far larger and he had no prospect of recouping his losses. The financial crisis triggered a prolonged recession. Several big banks and hundreds of industrial and commercial firms failed. Ultimately, Biedermann was liquidated, although, amazingly, the investors were all repaid. In the depths of the slump, Ludwig von Mises motioned another economist to his office window and, pointing down to the Ringstrasse, that symbol of Vienna’s liberal age, said gloomily, “Maybe grass will grow here because our civilization will end.”18

  If Schumpeter’s enemies judged him harshly, they didn’t condemn him nearly as severely as he did himself. He plucked a line from Dante’s Inferno—“Il gran rifiuto” or “the great refusal,” a phrase that connotes both a lost opportunity and a failure of nerve—to describe the decade since the start of the war; his entire thirties, more or less. At forty-one, he found more to regret than to look forward to.

  The black mood didn’t last. The need to defend himself and to find a way to make money energized him. And at the end of his annus horribilis he found a reason to smile again. Like most Don Juans, Schumpeter had been infatuated—even obsessed—countless times, but he had never been truly in love. Annie Reisinger disarmed him because she was young, working class, and vulnerable. She was the twenty-one-year-old daughter of the concierge of his mother’s apartment building. He had known her since she was a baby. When she was eighteen, he had begun a mild flirtation with her, only to be rebuffed. She had been more frightened by his reputation as a womanizer than by the fact that he was a public figure twice her age. He had run into her again on Christmas Day when she paid his mother a visit. She was prettier, more womanly, and more self-possessed than he remembered. Jaded as he was, he found her cheerful good nature and lack of intellectual pretention refreshing.

  He was lonely and sore. She was recovering from an unhappy affair with a married man. They were both
on the rebound. Schumpeter made a project of their romance. He courted her daily. He swept her off to operas, balls, restaurants, and weekends in the country. He showered her with flowers and expensive trinkets. When he asked her to marry him, he went down on his knees.

  Appalled as his mother may have been at the prospect of a shopgirl as a daughter-in-law, she bit her tongue. A man who was as notorious as he was penniless was hardly in a position to make the brilliant match she had craved for him. Besides, he was still legally married to his first wife. Schumpeter had not seen Gladys, who had since resumed the use of her maiden name, since they parted in 1913. It isn’t clear whether she had refused to consider a divorce or he simply hadn’t bothered to ask for one. What is plain is that they were still legally married and that Gladys, if she wished, could have prevented his remarriage or sued him for bigamy. Luckily for Schumpeter, the Socialist government of Red Vienna had liberalized the divorce laws, and a friendly official granted him a civil waiver to marry Annie. Annie overcame her own and her parents’ misgivings and went along.

  Meanwhile, Schumpeter’s friends were looking for ways to rescue his career. Despite his misadventures in politics and banking, his reputation as a brilliant economic theorist had survived. True, he had made enemies in Vienna and Berlin who would block his appointment at either of those cities’ universities, but many others abroad, including the University of Tokyo, were eager to recruit him. Ultimately, the University of Bonn, the first university out of which Karl Marx had flunked, offered him a chair in public finance. “Schumpeter is a genius,” began a letter from one of his supporters to the cultural ministry in Berlin. German universities were completely cut off from contemporary economics, the writer pointed out, and Schumpeter would turn Bonn from a backwater into an important center of theoretical economics.