Lords of Finance

You could not step twice into the same river; for other waters are ever flowing on to you.
– Heraclitus of Ephesus

Liaquat Ahamed's Lords of Finance is an excellent read on the financial predicaments of the 1920s. Though we face different circumstances today, Ahamed's history of the era offers much understanding on how we got here, providing valuable knowledge on where we need to go.

Lords of Finance focuses mostly on the four men who ran the central banks of the US, Britain, France, and Germany in an era of great financial turbulence leading to the Great Depression. It is an excellent popular history, painting a wonderful picture of the era and of those whose helped, for better and worse, to define it. It also does a good job of laying forth the financial conundrums in a way people can understand.

Mr. Ahamed's main contention is that the gold standard was the main culprit behind the currency turbulence of the 1920s. However, I think the story he tells leads to a little different conclusion -- debt was really the main problem -- and the gold standard both a catalyst aggravating the situation and a hindrance in developing solutions. The end of WWI saw a much different world than the beginning, especially in the financial sector. Most important, three of Europe's great powers became indebted to each other and the new American financial colossus, representing a shift in underlying economic power that would cause havoc for the next ten years. Ahamed writes:

They burdened a world of economy still trying to recover from the effects of war with gigantic overhang of international debts. Germany began the 1920s owing some $12 billion in reparations to France and Great Britain; France owed the United States and Britain $7 billion in war debts, while Britain in turn owned $4 billion to the United States. This would be the equivalent today of Germany owing $2.4 trillion, France $1.4 trillion, and Britain owing $800 billion. Dealing with these massive claims consumed the energies of financial statesman for much of the decade and poisoned international relations. More important, the debts left massive fault lines in the world financial system, which cracked at the first pressure.

In his seminal The Economic Consequences of the Peace, Keynes wrote the war debt, particularly the punitive reparations placed on the Germans, would lead to economic calamity. Over the course of the next decade, Germany, Britain and France would scramble to keep this debt from crippling their domestic economies and exports. The debt led to continuous currency volatility, including Germany's hyperinflation of the early 20s and then the collapse of the entire system by the end of the decade.

Lords of Finance is the story of the constant interaction between the four nations' central banks and their attempts to create a stable currency situation, with the US playing the role of lender of last resort. Mr. Ahamed shows how sticking to the gold standard aggravated the situation and getting off the gold standard eventually alleviated some of the problems. However, the debt and underlying real economy imbalances in the system would take a decade and half and another world war to come to a resolution.

The gold standard was not so much a cause of the currency destabilization as a catalyst. It forced more frequent and severe valuations and revaluations then was necessary. Gold is an anti-inflationary money base and inflation is finance's worst enemy. All debt loses value with inflation, thus if you want the money you lent back, you want to keep inflation at a minimum. The natural scarcity of gold helps curb, but does not prevent inflation.

This is important for understanding the present global economic predicament. The question of debt, not just in the US, but in Greece and other nations in Europe is leading the news. Yet, even without the gold standard, debt is causing increasing turbulence in currency markets. Our modern lords of finance are just as fearful of inflation as their predecessors, and while they don't have gold, they have derivatives and other financial innovations as a catalyst. They are fearful of losing their money. They are slowly turning the screws on many nations to create no more debt and pay what they owe. The debt and increasing volatility are beginning to jam the wheels of commerce.

The debt problem of today is exponentially larger than the 1920s. In the past decades, we have added layer upon layer of "innovative debt" on top of more traditional debt. Advocating more debt, without getting rid of existing debt, will slowly strangle the future. Mr. Keynes understood this better than his disciples.

Just as after WWI, the debt and currency volatility are pointing to underlying real economy imbalances. Unlike in the 1920s, the US is not the planet's largest creditor, it is the largest debtor, yet it still plays the role of lender of last resort. Ahamed writes of the 1920s:

Eventually the policy of keeping US interest rates low to shore up the international exchanges precipitated a bubble in the US stock market.

Today, Mr. Bernanke keeps interest rates low and pumps up not only the US stock market, but creates new bubbles across the globe. Neither this or the debt ocean created in the last thirty years is sustainable.

We have new lords of finance. While the Fed remains powerful, debt has grown to such a degree to make it less so. Over the years, the Fed has ceded power to our new lords of finance on Wall Street and in the mega-banks, who have created more debt in the last several decades then the world has seen in all its previous history. At some point, just as the WWI war reparations and war debt was written down or off, we are going to have to do the same without cratering the economy. We need to dethrone the new lords of finance and place the real economy, in all its diversity and concreteness in charge. We need to bring this queer thing known as money down from the marble palaces and into the democratic assembly.