http://www.nytimes.com/2009/02/15/books/review/Nocera-t.html?_r=1&8bu=&emc=bua1&pagewanted=all

 

Sunday Book Review

 

 

Flying Blind

 

By JOE NOCERA

Published: February 13, 2009

“We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand.”

LORDS OF FINANCE

The Bankers Who Broke the World

By Liaquat Ahamed

Illustrated. 564 pp. The Penguin Press. $32.95

Related

First Chapter: ‘Lords of Finance’(January 15, 2009)

Up Front: Joe Nocera (February 15, 2009)

'Lords of Finance,' by Liaquat Ahamed: A Monetary Horror Story That Looks Like Today’s(January 15, 2009)

Times Topics: The Great Depression | Credit Crisis -- The Essentials

So wrote the great economic iconoclast John Maynard Keynes in an essay titled “The Great Slump of 1930,” published in December of that year. Thirteen months had passed since the crash of 1929; the world was living, in Keynes’s words, in “the shadow of one of the greatest economic catastrophes of modern history.”

I shuddered when I read this quotation in “Lords of Finance,” a magisterial work by Liaquat Ahamed, a veteran hedge fund manager and Brookings Institution trustee. A grand, sweeping narrative of immense scope and power, the book describes a world that long ago receded from memory: the West after World War I, a time of economic fragility, of bubbles followed by busts and of a cascading series of events that led to the Great Depression.

The “delicate machine” Keynes referred to was of course the global economy. By 1930, when he wrote his essay, the West was in bad shape. A combination of divisive postwar politics, a refusal to abandon economic orthodoxy and a series of policy errors by the world’s four most important central banks — the Federal Reserve, the Bank of England, the German Reichsbank and the Banque de France — had led to the near collapse of capitalist economies in the West. “Industrial production had fallen 30 percent in the United States, 25 percent in Germany and 20 percent in Britain,” Ahamed writes. “Over 5 million men were looking for work in the United States, another 4.5 million in Germany and 2 million in Britain.”

And yet — and this is why I shuddered — it was also a moment not unlike the one we’re living through now. As scary as things were, it was clear that the abyss had not yet been reached, and there was still a chance that the global economy could pull back from the brink. With the right moves from the central bankers — and a little luck — the Western economies might yet right themselves. In December 1930, the world was holding its breath.

Alas, it was not to be. Six months later, an Austrian bank collapsed, resulting in a run on the rest of Austria’s banks. The central bankers responded both belatedly and tepidly, failing to stem the run and then making a new round of policy errors that compounded matters. By 1932, the United States had entered the worst year of the Great Depression — while in Germany Hitler’s ascent was assured.

The lords of finance who constitute the title of this book are the four central bankers who dominated that postwar era: Benjamin Strong of the Federal Reserve Bank of New York; Montagu Norman, the longtime head of the Bank of England; Émile Moreau of the Banque de France; and Hjalmar Schacht, who headed the Reichsbank. Ahamed says he got the idea for this book when he read a 1999 Time magazine cover story headlined “The Committee to Save the World,” about Alan Greenspan (then the Federal Reserve chairman), Robert Rubin (Bill Clinton’s Treasury Secretary) and Lawrence Summers(Rubin’s No. 2). He realized that in the 1920s, the four top central bankers had acquired a similar mystique and fame; they were sometimes described as “the most exclusive club in the world.” He decided to tell the story of “the descent from the roaring boom of the ’20s into the Great Depression” by “looking over the shoulders” of these four men.

From a literary point of view — and let me pause to note that this is a beautifully written book; Ahamed has a gift for phrase-making and storytelling that most full-time writers would envy — the decision to build “Lords of Finance” around these four men is a brilliant conceit. Each of them was a powerful personality, with the full range of strengths and weaknesses, insights and eccentricities. Because much of the book concerns decisions, for instance, to raise or lower interest rates, you need great characters to pull the story along, and Ahamed not only has them but also knows how to make them come alive. Strong is the domineering American; Schacht the arrogant, headstrong German; Norman and Moreau the prideful Europeans. Strong and Norman became close friends, and their letters to each other are a rich source of material, sometimes quite touching.

But as Ahamed’s narrative makes clear, it’s also a little unfair to portray these men as “the bankers who broke the world,” as the subtitle phrases it. For one thing, by the middle of 1931, Norman was the only one of the four still in his job. (Strong, who for all intents and purposes invented the role of Federal Reserve chairman, died in 1928.) For another, they each became famous not because of their mistakes but because of their triumphs. To take the most striking example, Schacht, a prosperous banker, was made Germany’s “currency commissioner” in November 1923, when that country’s hyperinflation was completely out of control. (How bad was it? “On Nov. 5,” Ahamed writes, “the price of a two-kilo loaf of bread had soared from 20 billion marks to 140 billion, sparking off nationwide riots.”) In a brilliant stroke, Schacht created a new currency, the Rentenmark, then chose the exact right moment to fix it to the mark (at 1 trillion marks to one!). In so doing, he restored faith in Germany’s currency and beat back inflation. The German press took to calling him the “Miracle Man.”

Besides, the central bankers were prisoners of the economic orthodoxy of their time: the powerful belief that sound monetary policy had to revolve around the gold standard. That is, each country’s reserve bank had to have a certain amount of gold in its vaults to back up its currency — and indeed, “all paper money was legally obligated to be freely convertible into its gold equivalent,” as Ahamed says. Again and again, this straitjacket caused the central bankers — especially Norman, gold’s most fervent advocate — to make moves, like raising interest rates, that would allow their countries to hold on to their dwindling gold supplies, even though the larger economy desperately needed help in the form of lower interest rates.

Finally, Ahamed lays the blame for much of the economic turmoil of the 1930s on an issue the central bankers had no control over: the insistence by the Allies that Germany pay war reparations far beyond its means.Norman in particular was fiercely opposed to the size of the reparations the Allies were demanding, arguing that they would bring down the German economy — which is precisely what happened. By the early 1930s, less than eight years after hyperinflation had been brought under control, Germany was effectively bankrupt, and German resentment over the onerous efforts to extract billions in reparations helped pave the way for Hitler.

You read Ahamed’s sections on reparations — and there are lots of them because the issue dogged the world for more than a decade — with a growing sense of horror, knowing how it all turns out. But you also read this book with a growing sense of recognition. As you learn how the world spiraled into depression, about the interconnectedness of the banking system, where a failure in one country led to problems in other countries, about the way economic orthodoxy caused brilliant central bankers to make mistake after mistake, and on and on — you can’t help thinking about the economic crisis we’re living through now.

The central bankers of the 1920s and ’30s were flying blind; Ahamed makes that quite clear. They could only hope the moves they made would help the economy instead of hurting it. Sometimes they were right, but often they were wrong. We like to think that today we have a better grasp of the machinery that moves an economy — but do we? Federal Reserve Chairman Ben Bernanke and former Treasury Secretary Henry Paulson were much quicker than the earlier lords of finance to throw money at the banking system to prevent it from collapsing, a lesson they learned from the inaction of the Federal Reserve in the 1930s. But Paulson also allowed Lehman Brothers to default, an event that set off a contagion of failure around the world.

Here at this critical moment, with a new administration having just taken office, and with so much riding on its policy responses to the current crisis, “Lords of Finance” poses an unsettling question. Do we really understand the workings of that delicate machine any better than our forebears did? Or do we only think we do?

Joe Nocera writes the Talking Business column for The Times.