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Lessons from the "Lords of Finance"



I am not able these days to make as much time as I would like to read whole books, but during a recent vacation I was able to finish Lords of Finance by Liaquat Ahamed. I recommend it to anyone interested in the interwar period of the 1920s and 1930s, both before and after, and how that experience may relate to the recent economic and financial crisis. It is a good and easy read, even at 500 pages. Some personal thoughts and reactions:

The "lords" are Montague Norman of the Bank of England, Benjamin Strong of the Federal Reserve Bank of New York, Hjalmar Schacht of the Reichsbanks/Bundesbank, and Emile Moreau of the Bank of France. None of these gentlemen comes across as a hero or a particularly attractive person. Strong comes closest, but he died as the Depression started, was only a part-time central banker because of his health problems, and was too attracted to the gold standard. John Maynard Keynes comes out a bit better in terms of his thinking, but not in terms of his personality. But the descriptions of these people, with a bit of gossip mixed in, add to the enjoyment of the read.

I learned what I was not taught (for example by Willard Thorp at Amherst or Bob Triffin at Yale) about the reparations debates after the end of World War I. We in the United States were not as innocent as the standard US-oriented narrative suggests. We lent the United Kingdom and France a lot of money during the war, and we insisted on getting each dime back, which in the end meant that United Kingdom and France had to get their dimes from Germany even if their leaders, or at least some of them, ultimately were inclined to relax their onerous demands for reparations from Germany. US intransigence no doubt interacted with the general isolationism that overtook US policy after WWI that Strong was actively trying to counteract.

Of course the return to the gold standard is the villain of the piece—see Keynes. But what I learned from reading this book was that no country played by the gold standard "rules," which were that if you acquired gold (the United States and France), you would expand your money supply and inflate (thus experiencing a real appreciation of your pegged nominal exchange rate), and if you lost gold (the United Kingdom and Germany), the reverse. The adjustment process (see concerns about global imbalances today) was disabled by policy choices. For a while, the system was sustained by private capital flows into Germany and the United Kingdom until what is now called a "sudden stop" occurred.

Ahamed presents an interesting interpretation of the failure of US monetary policy: It was not that the Federal Reserve did not ease interest rates (which is the standard textbook lesson derived from Friedman and Schwartz, who focus on the behavior of bank reserves). The Federal Reserve did lower interest rates substantially but did not act to save the banks after it had eased. In the context of the current/recent crisis, the implication is that what Bernanke et al. did was correct in rescuing the financial system, but the Ahamed view certainly is not the essence of the dominant, current narrative in the United States today or the conventional wisdom on the Depression

As a former official of the Board of Governors of the Federal Reserve System from 1972–98, I found that the stories about the intrigue within the Federal Reserve and the fact that Strong and his successor Harrison acted as if they were "lords" rather than government officials resonated with me. Long after the structure of the Federal Reserve was changed in the 1930s to put the Board of Governors in Washington in legal control of international affairs, these battles were still being fought. Today, the system is much more cohesive. For better or worse, the Federal Reserve Bank of New York does not have its own international financial policy.

The interesting thing about the Depression is that it took so long to unfold, but that is true of the recent crisis as well. The Federal Reserve did act starting in 1928 to pop the asset bubbles, triggering the German collapse, according to Ahamed. It overachieved its goal in 1929. Maybe that is why Alan Greenspan and his colleagues did not do so in this century. But after October 1929, it was years until the full crisis unfolded. The recent global economic and financial crisis also was more drawn out than some appreciate, starting in the summer of 2007 and not reaching a crescendo until September 2008. But the recent crisis still was much more compressed.

Lords of Finance is well worth reading, but it is a selective history that covers half a century. In the epilogue, Ahamed draws parallels with financial crises in the 1990s and 2000s. He has some of his facts wrong, e.g., in the Asian financial crisis the governments of Thailand, Indonesia, and South Korea did not suspend payment on their sovereign debts or on private debt, though much of the latter went into default. That is written history for you—not truth but interpretation!

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