It’s been tried before and found ruinous — from our new May issue.
It is commonplace today to believe we should refer to the benign innovations of John Maynard Keynes during the Great Depression in order to understand what is driving President Obama’s team of economic strategists. But a look back to that time leads one to conclude the Depression-era economist who appears most relevant to what is going on bears the improbable name of Hjalmar Horace Greeley Schacht.
From his post as head of the Reichsbank, in a career that ran nearly 20 years, Schacht was in effective control of the shambolic German economy for successive Weimar Republic governments and the pre-World War II regime of Adolf Hitler. During that time he routinely talked one game and ran another. He was a vocal supporter of returning the global marketplace to the fictional discipline of the gold standard even as he implemented inflationary policies to jump-start a society paralyzed by chaotic politics at home and foreign demands for war reparations that had to be finessed at all costs. Much of what Schacht did found its way into Keynes’s landmark 1936 treatise, The General Theory of Employment, Interest and Money. Indeed, Keynes nodded in Schacht’s direction in the foreword to the German edition of his book, where he stated his economic theories “can be much easier adapted to the conditions of a totalitarian state than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire.”
Before devotees of our prince-president start reaching for their pitchforks and tar buckets, let’s be clear that the brand of national socialism now being practiced in Washington has nothing to do with the capital-lettered National Socialism that drove the horrible Hitler regime or the equally disgraceful brands of big-F Fascism practiced by Mussolini, Franco, Peron, and other despots of the last century and this. Schacht himself was a stiff-necked and bumptiously offensive self-promoter but he was never a Nazi, a fact Hitler himself recognized by putting him in a concentration camp toward the war’s end. And while the revenge-minded Allies tried him for war crimes, even the Nuremberg judges acquitted him. It is not a war crime to be a central banker, although it is a thought.
Obamanomics, if that is the word, also bears little resemblance to the idealized soft-socialism we attribute to the FDR era, or what came in harder form in the wave of nationalizations and state-owned enterprises that the Labour Party tried to run in Britain, or in the capital-S Socialist governments that held sway over the European Union. Neither Larry Summers nor Timothy Geithner nor Federal Reserve Board chairman Ben Bernanke want to take over the management of Wall Street’s banks, let alone have to set up complex government agencies to operate General Motors or any other business sector further down the Toxic Asset Rescue Plan food chain.
Instead of actually trying to take over the formal management of the private sector, the Obama plan is to use the printing presses of the Federal Reserve as a powerful lever to force private enterprise to serve the administration’s social agenda. Congress, pacified with pork injections, will have no policy role.
State governments, which once were seedbeds of innovation, are on a short leash held by the White House. When the president pointedly told a White House audience of big-city mayors, “We will be watching you,” it was not merely a warning to handle the anticipated flow of federal funds with probity; it was an injunction that programs with the administration’s imprimatur were to be given priority.
So it is not the socialism of the Old Left at work. To recognize this is to understand the growing undercurrent of fretful unhappiness festering among traditional liberal Democratic pols like House Speaker Nancy Pelosi or appearing on the far-left blogs of Daily Kos and the Huffington Post. But from the right or left, what’s happening is still alarming if one believes in free markets and a free society.
WHILE THE THREAT OF A new form of governmental diktat by printing press is troubling enough in the sense of lost civil liberties, consider this: What if it doesn’t work, doesn’t jumpstart things? Or, worse, what if Obamanomics is a cure for an ailment that turns out to be not as threatening as it was on Inauguration Day, and actually tail-spins us into a new cycle of artificial boom followed by, a couple of years hence, an even deeper spiral of financial paralysis, market failure, and collapse?
It has become a cliché in its own right that history does not repeat itself. But certainly the history of Hjalmar Schacht gives a frightening hint of what disasters lie ahead when economic policies are formed by tiny groups of elitists removed from any official oversight and insulated from the abrasive but necessary challenges of a democratic political system. In what turned out to be two separate careers, Schacht and three other close personal friends can be fairly said to have caused the 1 92 9 c rash and then to have muddled around making things worse in the Great Depression that followed.
The three chums, it turns out, were the heads of central banks themselves, the Bank of England, the New York Federal Reserve Bank, and the Banque de France. Starting in the early 1920s this quartet set out to create a new global financial system to replace the one shattered by World War I and left in dysfunctional crisis. The four, not surprisingly, became international media celebrities. “The Most Exclusive Club in the World” was the press nickname for their frequent secret conclaves. Their closeness was magnified by the absence of much input from the elected officials they nominally served.
Presidents, prime ministers, dictators, and especially national legislatures apparently had such an ignorant indifference to monetary strategy that they anxiously deferred to the dictates of the quartet of men judged to be wizards. There might be a slight historical echo in the current lack of real curiosity about what exactly the economic philosophy of President Obama might be so as long as Larry Summers, Timothy Geithner, and Ben Bernanke are standing in front of him. Instead of the four friends of the Exclusive Club, we now have the Three Amigos.
The Bank of England’s governor, Montagu Norman, was an eccentric, fragile dilettante determined to restore the bank to its prewar dominance of global finance. Norman was a press favorite, the very model of a British central banker. He sported a Van Dyke beard, velvet-collared cape, and slouch hat and made his transatlantic voyages to Club meetings under assumed names. He also was prone to emotional collapses at moments of crisis.
Benjamin Strong was chairman of the New York Federal Reserve Bank, which nominally was just one of 12 ill-defined regional institutions established in 1913. But since the Great War it clearly had succeeded to the Bank of England’s place in the sun. Strong looked like the classic Ivy League athletic type but in fact had become a bank clerk out of high school. Often sidelined with chronic tuberculosis and depression, Strong battled the fierce protectionist public mood and almost invincible ignorance within the U.S. Congress and White House to keep the United States internationally involved and globally dominant. Emile Moreau, the director of the Banque de France, was burdened by a rancorous personality in part caused by trying to restore his war-shattered nation’s international role as a trade and financial power abroad while at home he faced a political chaos where governments lasted for hours instead of years.
Norman and Moreau were determined to squeeze Germany for payments without killing the goose while they both diluted the wartime debts their own governments had incurred from America. There was just so much each could do for the other since at no time did their governments trust each other. Strong was determined to help all three revive as trading partners and repay their U.S. war debts, but without weakening the postwar boom in new American bank loans and export sales to all of Europe. Schacht, whose only hand during the frenzied 1920s was to use the threat of a default on Germany’s reparations, played them all. Yet the four maintained a personal intimacy with one another; they holidayed together, became family friends, and by today’s standards it all seems a little odd.
OF COURSE THE COMMITMENT OF the four central bank chiefs to revive the world was doomed to failure because it was founded on the myth that a return to pegging their currencies to a fixed measure of monetary gold was the key to stability and a return of public confidence. Gold in those days occupied the role held today by the myth of the almighty American dollar as the international vehicle for trade and finance. The comparison is apt. There was, by estimate, about $6 billion in monetary gold ($1.2 trillion by today’s purchasing power) in the central bank vaults of the four nations, more than $4 billion of which was stashed in Strong’s basement at the New York Fed.$
To meet the needs of expanding economies, the gold standard that by necessity most nations adopted after the war imposed a system of exchange rates that raised a constant threat of devaluation and inflationary price spirals. So today, the dollar held by American foreign trade partners from China to Dubai has been systematically devalued by successive administrations through budget deficits and trade account losses. Now, as then, Mr. Bernanke is devaluing Mr. Obama’s debt obligations by buying U.S. Treasury bonds with new printed currency.
But also now, as then, markets tend to adjust when one nation is a chronic profligate. Back then, faced with complaints that British and French loans from Wall Street were hampering their revivals, President Calvin Coolidge laconically observed: “They hired the money, didn’t they?” More recently, the estimable Paul Volcker, head of Mr. Obama’s Economic Recovery Advisory Board, could counter Chinese complaints that their dollar holdings were being evaporated only slightly less laconically: “They hold all these dollars because they chose to buy the dollars, and they didn’t want to sell the dollars because they didn’t want to depreciate their currency. It was a very simple calculation on their part, so they shouldn’t come around blaming it all on us.”
So it was in 1927 when the four central bank wizards met in secret for five days at a palatial estate on Long Island. The postwar boom was asphyxiating, especially in Europe and perhaps fatally in Weimar Germany. The three European central bankers desperately needed more gold in their vaults to fluff up the amount of liquidity needed to keep economic growth expanding. Strong agreed to cut U.S. interest rates; that’s what friends do. In response, investors moved their capital to the higher yields in Europe and gold accompanied it. Frenetic activity resumed and banks scrambled to lend more to cover growing debt burdens. The countdown to the 1929 crash was under way. There were credit swap agreements that no one could understand. There was Ivar Krueger, who built a Bernie Madoff scam selling Swedish match franchises. With each bank failure and industrial bankruptcy, governments demanded that the four central bankers and their compatriots provide ever more liquidity in volumes no economic tax base could ever redeem.
TO UNDERSTAND IN DETAIL what was happening then and its impact on current events, there are two authoritative books to read in sequence on what happened next. Lords of Finance (Pen guin) by former World Bank analyst and hedge fund manager Liaquat Ahamed chronicles with a slow- motion fascination how the four, as he says, “broke the world.”
Adam Tooze, a Cambridge economic historian, delved deeply into German civil and financial archives to document how Schacht was able to negotiate the shifting political ice floes between Weimar chaos and Hitlerian horror. In his book, The Wages of Destruc tion (Penguin/Allen Lane), he documents how Schacht was able to bounce back from dismissal from the Reichsbank in 1930 as the systemic global crash washed the Weimar experiment away. Yet he regained the Reichsbank chair in 1933 in a regime he had sneered at. He returned to power, in effect, by participating in an even greater fraud. Even Adolf Hitler, who boasted of his uninterest in economics, justified putting him into the bank and then making him head of the overall economy, citing Schacht’s “consummate skill in swindling other people.” All Hitler wanted was money for guns and the appearance that jobs were being created. Until Hermann Goering ousted him on the eve of war in 1939, Schacht pumped things up with a will. As Ahamed reports:
Displaying the inventive genius that distinguished him as the most creative central banker of his era, immediately upon taking office, Schacht threw the whole baggage of orthodox economics overboard. He embarked on a massive program of public works financed by borrowing from the central bank and printing money. It was a remarkable experiment in what would come to be known as Keynesian economics even before Maynard Keynes had fully elaborated his ideas. Over the next few years, as the German economy experienced an enormous injection of purchasing power, it underwent a remarkable rebound.
But as Tooze documents, much of that rebound was a façade. Dramatic photos notwithstanding, the network of autobahn superhighways never produced that many jobs. Germany’s agriculture remained stunted and its lack of crucial industrial resources made manufacturers increasingly vulnerable to foreign suppliers who demanded more foreign exchange than Schacht could earn. In the end, Tooze argues, Hitler faced the necessity of conquering new territories throughout Europe in order to forestall an economic day of reckoning just months in the offing.
One comes away from these books with two troubling questions: Just how responsible are Schacht and the three other central bank wizards for the slippery slide into World War II? And how likely are President Obama’s three wizards—Summers, Geithner, and Bernanke—to be successful trying much the same remedy today? No less than Chairman Volcker, who after all knows how the Fed should do its job in a crisis, confesses alarm. He warned recently, “We’re in a government-dependent financial system; I never thought I would live to see the day.…We’ve got to fight to get away from that.”
The ghost of Hjalmar Schacht must smile.
James Srodes, an author and broadcaster, is a former Washington bureau chief for Forbes and Financial Worldmagazines. His latest book, On Dupont Circle: Franklin and Eleanor Roosevelt and the Progressives Who Shaped Our World, is being published next week. His email address is email@example.com.
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