Introduction
You live in a complex global financial system where you must constantly navigate the threat of sudden economic collapse and market contagion. You want to understand how central banks shape these systemic crises and why monetary policy decisions often backfire with devastating real-world consequences. Liaquat Ahamed addresses this problem by examining the lives and policies of the men who ran the world's central banks during the financial catastrophe of the 1920s and 1930s.
A quartet of central bankers rebuilt the global financial system after World War I on fragile gold foundations, ultimately triggering the Great Depression through their policy blunders.
The book traces this dramatic history across several distinct phases. You will explore the pre-1914 golden age, the rise of the four dominant central bankers, and the devastating monetary costs of World War I. You will then witness the descent into German hyperinflation, the complex web of war debts, and the artificial stabilization attempts of the mid-1920s. Finally, you will see how these policies culminated in the Wall Street bubble and the policy failures of the Great Depression.
You might ask several key questions as you read:
- How did the pre-war gold standard create a false sense of permanent economic stability?
- What psychological traits and national rivalries drove the key central bankers of the era?
- Why did the return to gold after 1918 lock major economies into prolonged deflation?
- How did central bank interest rate cuts in 1927 fuel the Wall Street stock market mania?
- Why did central bankers refuse to act as lenders of last resort during the 1929 crash?
1. The Sacred Gold Totem and the Illusion of Peace
Before 1914, the international gold standard served as the sacred economic totem anchoring world currencies and driving global trade and prosperity. Acting as the lifeblood of the financial system, the gold standard provided a store of safety and reinforced Victorian virtues of economy and prudence. Bankers in London, New York, Paris, and Berlin revered it with religious fervor.
Before 1914, the international gold standard anchored global prosperity, leading establishment figures to dismiss the economic rationality of a major European war.
The Sacred Gold Totem
Norman Angell argued in "The Great Illusion" that deep commercial and financial integration made war economically futile and irrational for all nations. Angell contended that disruptions to international credit would harm victors and vanquished alike, making the economic benefits of war entirely illusory.
Norman Angell published "Europe's Optical Illusion" in 1909 as a pamphlet, which became the book "The Great Illusion" in 1910, selling over a million copies by 1913 and translated into 22 languages.
Prewar Interdependence
Pre-war institutional interconnectedness produced extreme legal absurdities, such as British insurers being legally bound to compensate German enemies for sunken tonnage. The Committee of Imperial Defense discovered that because German merchant marine ships were insured through Lloyds of London, British firms would have to cover losses if the Royal Navy sank enemy ships.
During February 1912 hearings, the chairman of Lloyds testified that Lloyds was legally and honor-bound to cover losses if German ships were sunk by the Royal Navy.
Influential establishment figures like Lord Esher completely misjudged the probability of a major European war due to their total faith in economic rationality. Seduced by the achievements of La Belle Époque and trusting the economic inanity of war, figures like Lord Esher failed to foresee that a total war among Great Powers could erupt.
Lord Esher promoted Angell's theories by lecturing at Cambridge and the Sorbonne, declaring that new economic factors made a European war unthinkable.
2. Biographies of the Central Bankers
Montagu Norman, Hjalmar Schacht, Benjamin Strong, and Émile Moreau brought distinct psychological profiles and national ambitions to their leadership of central banks.
Montagu Norman
Born into an established banking family and educated at Eton, Norman suffered from persistent ill health, migraines, and severe nervous breakdowns. He struggled with severe psychological instability and manic depression throughout his life, despite his impeccable banking pedigree and elite background. Carl Jung misdiagnosed him with general paralysis of the insane in Zurich.
After a broken engagement in 1906, Norman suffered his first nervous breakdown, leading to reclusiveness, extensive travel, and an incorrect terminal diagnosis. He later utilized therapeutic stress-relief methods developed by Dr. Roger Vittoz to manage the Court of the Bank of England.
Hjalmar Schacht
Hjalmar Schacht overcame a lower-middle-class background and a feckless father through exceptional academic diligence and Germany's meritocratic educational system. His mother possessed noble Danish descent while his unstable father drifted through failed jobs in America and Germany.
Schacht attended the prestigious Johanneum gymnasium in Hamburg and eventually earned a doctorate in political economy before joining the Dresdner Bank. You can trace his rapid rise to his mastery of languages and rigorous classical schooling.
Benjamin Strong
Benjamin Strong accepted the governorship of the Federal Reserve Bank of New York, recognizing its potential to dominate the entire new system. Henry Davison and Paul Warburg persuaded him during a country weekend for the public good. Strong stepped down from lucrative private directorships to a $30,000 per year salary despite his $15,000 a year rent for his Park Avenue apartment.
On October 5, 1914, the Federal Reserve Bank of New York announced Benjamin Strong as its first governor. You see how a safe pair of hands took charge of American monetary policy at the outbreak of war.
3. Wartime Finance and the Abandonment of Sound Money
European belligerents funded World War I primarily through massive borrowing and central bank money printing rather than taxation, leading to severe inflation.
Funding total war through taxation alone would have required confiscatory rates. Governments instead relied on long-term borrowing and central banks. Central banks abandoned gold-backed currency issuance and printed money, often using complex accounting ruses to disguise currency expansion.
By 1916, five major powers including Britain, France, Russia, Germany, and Austria-Hungary spent $3 billion each month, consuming nearly 50 percent of their collective GDP. Britain spent a total of 43 billion dollars on the war effort over four years. France spent 30 billion dollars on its war effort.
Mechanisms of War Finance
Montagu Norman rose from an inactive background to become an influential adviser and eventually governor of the Bank of England for an unprecedented twenty-four years. He originally joined the Court of the Bank at age thirty-six in 1907. In 1915, Norman accepted an invitation to become adviser to deputy governor Brian Cockayne.
Governor Lord Cunliffe initially dismissed Norman as a queer-looking fish with a ginger beard creeping about the Bank like a lost soul.
Benjamin Strong leveraged his position at the Federal Reserve Bank of New York to dominate U.S. monetary policy and organize high-profile financing campaigns for World War I. As massive gold inflows flooded the United States, doubling the money supply, Strong coordinated monetary policy and led aggressive public campaigns to sell Liberty Bonds. U.S. bullion reserves reached 4 billion dollars following massive gold influxes.
Britain and France borrowed approximately 2 billion dollars yearly in the United States early in the war. The United States spent a total of 30 billion dollars on the war and raised 20 billion dollars through Liberty Bonds. Strong organized high-pressure publicity stunts in New York, including digging trenches in Central Park and sounding sirens and foghorns to promote war bond sales.
Monetary Doctrine Failures
The dominant monetary doctrine of early twentieth-century central bankers, known as the real bills theory, was fundamentally fallacious and encouraged inflation during crises.
The theory asserted that no inflation could result if banks issued loans exclusively to finance goods inventories rather than financial speculation. In practice, during periods of rising goods prices, this doctrine required banks to continuously expand credit, thus fueling inflation.
Central bank directors of the era were compared by a 1920s economist to ship captains who refused to learn navigation principles.
4. Reparations and the German Hyperinflation
The Versailles Diktat
Extreme political pressure and nationalist rhetoric at the Paris Peace Conference led to economically impossible reparation demands on Germany. Driven by domestic jingoistic campaigns and fear of a German revival, British hardliners like Lord Cunliffe and French leaders pushed for astronomical reparations. Cunliffe proposed a staggering $100 billion sum, which ignored basic economic realities and would have required interest payments amounting to 40 percent of Germany's prewar GDP.
Punitive reparation demands at Versailles and unconstrained money printing by the Reichsbank destroyed the German currency and middle class.
Lord Cunliffe admitted his $100 billion reparations figure was little more than a shot in the dark arrived at between a Saturday and a Monday. This policy of squeezing Germany until the pips squeak set the stage for total economic collapse.
The Hyperinflation Era
Unable to cover budget deficits and reparations through taxes, Germany resorted to frantic money printing that destroyed the currency's value. To finance huge social obligations, veterans' pensions, and passive resistance against the French occupation of the Ruhr valley, the Reichsbank printed exponential quantities of paper money. This triggered a runaway inflationary spiral where prices doubled every few days, making normal commerce impossible and forcing people to rely on barter or foreign currency.
Matthew Josephson lived like a king in a duplex with two maids and riding lessons for his wife on a salary of just $100 a month due to the extreme depreciation of the mark. By early November 1923, the exchange rate reached 630 billion marks per dollar. A kilo of butter cost 250 billion marks in late 1923, while unemployment hit 20 percent in the fall of 1923.
Hyperinflation eradicated the traditional German middle class while enriching speculators and asset holders. While industrialists with real assets and unionized workers temporarily coped, civil servants, teachers, doctors, and pensioners saw their lifetime savings and government bonds wiped out entirely. Meanwhile, agile speculators and foreigners amassed fortunes by buying up real estate, art, and jewelry at throwaway prices.
Imperial officers took jobs as bank clerks, professors begged on the streets, and young ladies from respectable families turned to prostitution. Berlin apartments worth $10,000 before the war could be bought for $500.
Reichsbank President Rudolf von Havenstein maintained a fatal policy of unconstrained money printing out of rigid duty and fear of domestic revolution. Faced with the dilemma of either stopping inflation and triggering a revolutionary workers' crisis or acting as the Allies' tax collector, Von Havenstein chose to supply the government with all the money it requested. Operating out of outdated gold-standard mental models, he completely miscalculated that a moderate inflation would rapidly spiral out of control.
On August 17, 1923, Von Havenstein proudly announced to the Council of State that the bank had the capacity to issue 63,000 milliards of total circulation, boasting of printing two-thirds of it in a single day.
5. War Debts and the Return to Gold
The entanglement of war debts and reparations forced Britain into a painful deflationary return to gold while the U.S. accumulated the world's monetary gold.
War Debts and Uncle Shylock
European powers borrowed heavily from each other and the United States during the war. Prior to the war, Britain controlled 20 billion dollars in foreign investments. By the end of the conflict, sixteen European allied powers owed 12 billion dollars to the United States.
Britain owed 5 billion dollars to the United States, and France owed 4 billion dollars. Meanwhile, seventeen countries owed 11 billion dollars to Britain.
When Britain and France attempted to link their capacity to pay war debts to the collection of German reparations, the United States insisted the issues were legally and morally distinct. This stance turned the obligations into a multi-generational economic burden. Maynard Keynes drafted a comprehensive reconstruction plan proposing fixed German reparations of 5 billion dollars via long-term bonds to pay off Allied war debts, but American delegates rejected it out of hand.
The British government declared it would collect no more from its debtors than the U.S. collected from Britain through the Balfour Note. This declaration provoked intense American resentment. European newspapers began portraying the United States as a ruthless usurer under the moniker Uncle Shylock. The Philadelphia Inquirer depicted John Bull as a magnanimous creditor and Uncle Sam as a relentless Shylock insisting on the letter of his bond.
Britain's Deflationary Ordeal
By the early 1920s, the United States held close to 4.5 billion dollars of the 6 billion dollars total global monetary gold reserves. This concentration left Europe with a chronic shortage and disabled the traditional functioning of the international gold standard. Huge hoards of gold were stored under lower Manhattan in the Treasury repository at Broad and Wall Streets and at the New York Fed, with 1.5 billion dollars stored directly in the Treasury repository.
Britain deliberately chose the path of severe deflation to restore the prewar parity of the pound. Inspired by the 1821 resumption after the Napoleonic Wars, the Bank of England raised interest rates to 7 percent in 1920 to cut prices by half.
Following the Cunliffe Committee recommendations, the Bank of England engineered a 50 percent drop in prices, successfully bringing the pound close to its prewar parity of 4.86 dollars from a low point of 3.20 dollars on foreign exchange markets. This policy stranded British industry with chronic high unemployment, leaving joblessness above one million for the next twenty years.
6. Stabilization and the Dawes Plan
The Rentenmark Mechanism
Hjalmar Schacht stopped the hyperinflation by establishing the Rentenmark currency on the theoretical backing of agricultural and industrial property rather than gold. The issuing bank placed a mortgage on all agricultural and industrial property, imposing an annual 5 percent levy or commercial real estate tax.
Schacht treated the land-backed currency as a confidence trick, but maintained its credibility by rigidly fixing its total supply.
The issuing bank fixed the total supply at 2.4 billion Rentenmarks, representing a dollar equivalent of 600 million dollars. Schacht refused loan requests from government agencies, municipalities, banks, and industrialists to strictly enforce this statutory ceiling.
Schacht executed a brilliant tactical delay in setting the currency conversion rate to exhaust the old currency's value and wipe out state debt. By waiting several days while the Reichsmark plummeted to 4.2 trillion per dollar on November 20, 1923, he allowed the old currency to become so worthless that the government wiped out its massive domestic debt for a fraction of its cost. The German government bought back trillions of old debt originally valued at 30 billion dollars for only 190 million Rentenmarks, or about 45 million dollars.
The Dawes Plan
The Dawes Plan introduced a supervised payment schedule, an escrow account managed by an American agent-general, and a massive foreign loan to protect the German currency. To prevent reparations from destroying the mark again, payments were deposited into a special escrow account controlled by a neutral American agent-general who decided when funds could be transferred abroad. Additionally, a large foreign loan was structured to jump-start the domestic economy and pay the first year of obligations.
The success of the Dawes Plan rested on a fragile international cycle of debt rather than a permanent solution to German reparations.
The committee proposed that Germany begin paying 250 million dollars in the first year, progressively increasing to 600 million dollars a year by the end of the decade. A 200 million dollar loan was raised abroad to help pay the first year. Because the plan deliberately avoided fixing the total reparations bill, underlying resentment remained in Germany.
When the German delegation held an all-night session at the London Ritz in August 1924, Schacht voted against accepting the final terms because failing to reduce total reparations was a fatal flaw, but Gustav Stresemann insisted they must accept to free the Rhineland. The entire recovery functioned through a great circular flow of paper where American banks lent money to Germany, Germany paid reparations to the Allies, and the Allies serviced their debts to the United States government. For his efforts, Charles Dawes was awarded the Nobel Peace Prize in 1925.
7. The 1927 Fateful Decision and the Wall Street Bubble
Benjamin Strong hosted Montagu Norman, Hjalmar Schacht, and Émile Moreau's deputy Charles Rist at Ogden Mills' estate on Long Island in July 1927. To help Britain stay on the gold standard and ease global deflation, the Federal Reserve cut interest rates by 0.5 percent to 3.5 percent across the New York Fed and eight reserve banks. Strong ruefully acknowledged the move would give the stock market un petit coup de whisky.
To rescue the British pound, the Federal Reserve cut interest rates in 1927, igniting the final speculative mania on Wall Street.
Following the Fed rate cut in August 1927, the stock market took off immediately, with the Dow rising over 20 percent to break 200 by the end of the year. Broker loans volume reached $4.4 billion by January 1928. From 1922 to 1927, corporate profits went up 75 percent. The Dow rose from 150 to around 200, a rise of about 30 percent in the second half of 1927.
The Wall Street Bubble
The late 1920s stock market bubble evolved from a conventional bull market into an irrational mania driven by widespread public speculation and leverage. The Dow doubled from 200 to a peak of 380 over fifteen months starting in the summer of 1928 while profits only grew at a steady ten percent per year. By 1929, between 2 to 3 million households engaged in the market, representing one out of every ten American households. Amateur speculators including shoeshine boys, household servants, and taxi directors opened brokerage accounts, famously prompting Joseph Kennedy to liquidate his portfolio in July 1929 when a shoeblack offered him inside tips.
The Federal Reserve was paralyzed by a bitter institutional standoff between the Federal Reserve Board in Washington and the New York Federal Reserve Bank over how to handle the stock market bubble. While the New York Fed repeatedly voted to raise interest rates, the Washington Board systematically overridden these rate hikes ten times. The Fed increased the discount rate from 3.5 percent to 5 percent from February to July 1928, but direct controls proved ineffective. Charlie Mitchell, head of National City Bank and a New York Fed director, openly defied the Board by announcing his bank would pump an extra twenty-five million dollars into brokers' loans to support the stock market.
The high interest rates and high returns on Wall Street drew capital away from Europe, starving Germany of foreign loans and pushing its vulnerable economy into recession. From 1924 to 1928, Germany borrowed 600 million a year, with interest rates in Berlin at 7 percent versus 5 percent in New York. Scheduled reparations payments under the Dawes Plan reached 625 million a year in 1929, representing about 5 percent of its GDP. German finance minister Rudolf Hilferding made a desperate call to Swiss banker Felix Somary to secure a twenty million dollar loan simply to pay public employee salaries.
8. The Great Depression and Central Banking Failures
Following the 1929 crash, central banks adhered to rigid gold rules and refused to act as lenders of last resort, turning a downturn into the Great Depression.
The 1929 Crash
On Black Thursday, October 24, 1929, a sudden flood of sell orders caused panic selling, leading leading Wall Street bankers to form a consortium and inject millions to temporarily stabilize the market. RCA stock suffered a 35 percent plunge during the initial panic when air holes opened up in the order books.
Prominent bankers including Charles Mitchell and Albert Wiggin met at J.P. Morgan & Co. and agreed to provide a buying pool. Richard Whitney walked onto the crowded floor of the exchange on October 24 and placed an order for ten thousand shares of U.S. Steel at 205, 5 points above the last sale price. The total cost of the blue-chip orders placed by Richard Whitney reached 20 to 30 million dollars.
Banking Panics and Gold Fetters
Central bankers misapplied Walter Bagehot's doctrine by refusing to assist insolvent banks, failing to recognize that letting them collapse would freeze the entire credit system. American central bankers rigidly followed this rule by letting failing banks collapse without realizing that doing so would trigger indiscriminate deposit withdrawals and destroy public confidence. The grandees of the New York Fed refused to bail out the insolvent Bank of United States, ignoring warnings from state banking superintendent Joseph Broderick that its closure would ignite the entire city.
This failure caused 450 million leaving the banking system in the months after the twin failures and a 5 billion shrinkage in bank credit by mid-1931. Britain attempted to maintain global financial primacy and lend heavily abroad by relying on short-term deposits rather than export surpluses. As foreign creditors called in deposits and drained gold reserves, the Bank of England lost 250 million dollars in the last two weeks of July, leading Britain to abandon gold.
Following the suspension of gold payments, the pound fell by nearly 25 percent, and twenty-five countries subsequently followed Britain off gold while the exchange rate of the pound dropped from 4.86 dollars to 3.75 dollars. Roosevelt's decision to abandon the gold standard and devalue the dollar broke the psychology of deflation by driving prices upward and reducing real borrowing costs. On the day the New York Stock Exchange reopened after the gold decision, the Dow jumped 15 percent, marking the largest single-day move in its history, while wholesale prices saw a 45 percent jump during the following three months.
10 Key Ideas
- Before 1914, the international gold standard anchored global prosperity, leading establishment figures to dismiss the economic rationality of a major European war.
- European belligerents funded World War I primarily through massive borrowing and central bank money printing rather than taxation, leading to severe inflation.
- Punitive reparation demands at Versailles and unconstrained money printing by the Reichsbank destroyed the German currency and middle class.
- Schacht treated the land-backed currency as a confidence trick, but maintained its credibility by rigidly fixing its total supply.
- The entanglement of war debts and reparations forced Britain into a painful deflationary return to gold while the U.S. accumulated the world's monetary gold.
- The success of the Dawes Plan rested on a fragile international cycle of debt rather than a permanent solution to German reparations.
- To rescue the British pound, the Federal Reserve cut interest rates in 1927, igniting the final speculative mania on Wall Street.
- Montagu Norman, Hjalmar Schacht, Benjamin Strong, and Émile Moreau brought distinct psychological profiles and national ambitions to their leadership of central banks.
- Following the 1929 crash, central banks adhered to rigid gold rules and refused to act as lenders of last resort, turning a downturn into the Great Depression.
- Roosevelt's decision to abandon the gold standard and devalue the dollar broke the psychology of deflation by driving prices upward and reducing real borrowing costs.