Lords of Finance

Title: Lords of Finance

Author: Liaquat Ahamed

Publisher: Windmill Books 2010 (First published: 2009)

ISBN: 978-0-099-49308-2

Pages: 505

Liaquat Ahamed was a professional investment manager turned writer, with working experience at the World Bank. He is adviser to many financial enterprises and has degrees in economics from Harvard and Cambridge universities. This is his first book, but judging from the mature and witty style, lots of infotaining books on finance can be expected from him. This work runs contrary to the public perception of books on finance being dull and boring. Ahamed has transformed the rules of the game and has presented a glorious example which should be emulated by other writers in this field. The immediate inspiration for writing this book, as confessed by the author, is the economic recession which set in during 2007-08 threatening to engulf a large swathe of national economies.

The book attempts to trace the sequence of events which led to the Great Depression of 1929-33 and how the world freed itself from the clutches of the economic octopus through the actions and follies of governors of central banks in the leading economies of the world, U.S., U.K, France and Germany. Ahamed delves into the lives of the bankers, Montagu Norman (U.K), Hjalmar Schacht (Germany), Emile Moreau (France) and Benjamin Strong (U.S.). We see them with curiousness tinged with alarm at the ineptitude of some of them in understanding the economic impacts, let alone developing ways of wading through them. The author gives the impression that bankers too are not immune from overreacting to unsettling events, thereby jeopardising investors’ money and confidence.

The reasons for the Great Depression goes back to 1914 when the first world war began. Europe was without major wars for 40 years and the relative peace had boosted up trade among the nations, making London the centre of elaborate international credit. Her bankers extended their reach to far flung areas and every soverign government had to deal through them to stay in international trade. The bankers were averse to war, as it would unsettle every aspect of financial activity. There was the curious case of Lloyds in London which had insured the German mercantile fleet compensating them in the event of British ships destroying German vessels. Such interconnectedness among the leading economies should have been proved a guarantee against war, but popular sentiment is a dangerous thing, which can sway this way or the other, depending on petty incidents which flare up mob frenzy. As it happened, the first world war broke out in August 1914, in the aftermath of the assassination of Austrian Prince Ferdinand in Serbia.

Onset of hostilities derailed European finance. National stock exchanges, except that at Paris closed down. As the major currencies were based on gold standard, in London people demanded gold in return for pound sterlings. British gold reserves dwindled, banks also downed shutters for a few days to avoid runs on bank. A good deal of European capital was employed in U.S during the pre-war period, which had to be paid back urgently. This caused the dollar to fall in value, with American tourists travelling in Europe suffering the worst. Many were evicted from hotels and had to spend their nights in the open, because their dollars were not accepted by traders. Thus, even though the U.S. was not a party to the war, had suffered due to the domino effect. The brutal war which claimed the lives of 11 million people elicited hardships in the monetary sphere too. Governments make money from three methods – taxation, selling bonds and printing money. During the war, many nations came out of gold standard (the practice of keeping gold in reserve equivalent to a percentage of printed money) and freely printed money. This boom in currency automatically devalued them and hyperinflation set in. Money supply doubled in Britain, reached three-fold in France and four-fold in Germany.

Treaty of Versailles ended the war, forcing Germany to accept defeat and pay reparations to the allies who demanded $32 billion, but had to settle for $12 bn. Germany was unwilling to pay. The situation was compounded by the fact that France and England, the major allies, were themselves under war debts to the U.S., which they hoped to pay back from the amount receivable from Germany as reparations. The U.S. firmly rejected all proposals to link the two accounts, terming them as separate issues. America was portrayed as shylock in European media. Flow of gold continued to U.S., while its stocks continued to decline in Europe. Excess gold in U.S. caused price rises and the Federal Reserve had to bypass some of the gold, rising accusations that the gold mined out from inaccessible places are again buried to equally inaccessible bank vaults.

Hyperinflation reigned in Germany and the skyrocketing prices prompted the Reichsbank to print currencies in ever higher denominations, sometimes running into trillions of marks. The vicious circle fed into itself and more currency prompted even higher prices. With no gold to back the mark, Germany introduced a new currency, rentenmark, whose value was based on land. The method was economically doubtful, but prices stabilised and inflation came down. International effort to bail out Germany from the turmoil bore fruit in 1924 as Dawes Plan, formulated under the leadership of Charles Dawes, later Vice president of U.S. As per the plan, U.S. and other foreign agents would issue loans to Germany, which it would utilise to build up its industry and reconstruction. The returns from the development would be used for paying reparations to the Allies as per a softer schedule. At the end, the Allies would pay back U.S. war debts. A magical European turnaround resulted and Dawes was awarded the Nobel Peace Prize. Upon pressure from U.S., Britain returned to the gold standard in 1925 with prewar exchange rates. Such artificial measures increased the pound’s value and British goods became dearer. The Dawes plan was so successful that Germany was heaped with foreign money. Even provincial towns used the cash to build opera houses and indulged in extravagant expenditure. They were sitting on top of a volcano, as many of the loans were of short-term, liable to be claimed back anytime. By 1926, central bankers began to be concerned with three major issues – rising stock market in U.S., excessive foreign borrowing by Germany and increasingly dysfunctional gold standard. Capital was flowing to U.S. to invest in the burgeoning stock market, with credit crunch becoming evident in Britain. The Fed eased credit by reducing the interest rates to 3.5% from 4%, causing Wall street to continue to go up during much of 1927. Even though the rate was increased to 5% in Feb 1928, the damage had been done. The upward spiral moved ahead.

Germany was dependent solely on foreign loans to prop up its economy. Out of the $3 bn loans, $1 bn was short-term, ready to be pulled out at any moment. The Wall Street boom dried up the money flow from America as the lenders found their stocks a more attractive investment. Prominent European lenders also channeled their money across the Atlantic to participate in the stock boom. To keep money within their nations, European central banks had to raise interest rates, thereby reducing credit. This action came at a time when unemployment was rising and shows the desperate measures Europeans were compelled to take. Economic slowdown began in Europe. On Sep 29, 1929, Clarence Hatry, a U.K businessman was arrested for bond fraud, which swindled $70 mn of investors' money. To cover their losses, British agents pulled out their money from Wall Street immediately and most equities fell by 20% on that day. The bubble was about to be burst. On Wednesday, Oct 23, 1929, a lot of sell orders knocked down the market by another 10%. The next day is called 'Black Thursday', as the index was down by 15% at the start of trading. A determined effort by New York banks to intervene in the market buying bluechip stocks helped stave off the crisis. At the end of the day, stocks rallied and index was off by only 2%. For the next two days, index went up and the banks could sell the stocks they purchased at a nominal profit. But on monday, Oct 28, 1929, huge selling began and the index was off by 14%. The day is called 'Black Monday'. There was no let up the next day too, as it is now remembered as 'Black Tuesday' (Oct 29, 1929). Curiously, it was the day Winston Churchill, who was on a visit to U.S., chose to visit the stock exchange! Such disastrous deals stretched broker loans given by banks to the extreme. New York Fed and banks stepped in and secured the loans so that the system is not broken down. By Nov 1929, markets stabilized to a fair value. European markets also fell, but by moderate amounts. While the market fell 40% in U.S., it was 16% in U.K, 14% in Germany and 11% in France. However, credit was eased and interest rates were down to as much as 2.5%.

Recession began in the U.S. Industrial production fell by 30% in U.S., 25% in Germany and 20% in U.K. France was only moderately affected. There were 5 million jobless in U.S., 4.5 million in Germany and 2 million in U.K. Commodity prices dipped by as much as 50%. Wholesale prices fell by 15% and consumer prices by 7%. To add to the voes, a bank named Bank of the United States broke down, setting in motion a cascade of bank failures, due to runs on the deposits. Close on the heels came the bursting of real estate bubble in Chicago. In Europe too, bank closures began with the defaulting of Credit Anstalt, an Austrian bank. This caused a run on Austrian banks and German economy which are psychologically connected to Austria's. German employment scaled new heights of 6.5 million and the public discontent made the Nazis the second largest party in Reichstag. The condition of living in Germany had deteriorated so much that when Reichswehr (German military) decided to recruit 6000 men, 80000 people showed up, half of them undernourished! Herbert Hoover's (the then U.S. President) plan to declare a moratorium on war debts payments didn't ease the situation. Leading Germans banks were tottering and with no source of long term credit, the system collapsed. There were speculations among leading financialists that the capitalist economy was disintegrating all over the world.

The recovery was equally dramatic. U.K came out of the gold standard on Sep 21, 1931. This action devalued the pound which made British goods cheaper. Central banks which had pound reserves suffered badly, but British production moved up. America was still in doldrums, as by the end of the year, 2294 banks were closed. It was the year 1931 in which the recession turned into 'The Great Depression'. Stock markets lost 90% of value, prices were falling and almost a quarter of the workforce was jobless. Franklin Roosevelt assumed office in March 1933 and immediately declared national bank holidays, until the situation improved. Bank runs stopped and Roosevelt devalued the dollar, without officially going away from the gold standard and economic activity restarted. The book goes on to describe the most prominent financial events during and after the second world war too.

The book is very entertaining to read. It brought out in vivid detail as any national economy could be floundered due to the ill-conceived notions of a few central bankers. Their actions and inactions are far reaching, particularly so in today's connected world. In those days, people had to physically come to the banks and stand in line to withdraw money. Today, they can move huge amounts with nothing more than a few mouse clicks. Hence a bank run today would be much more grave. However, the author assures us that a major catastrophe on those scale might not happen because the central banks are more vigilant now and there is a mechanism in place for ensuring international credit in the form of IMF and World Bank. The book is a very palatable mixture of wit, facts, analyses and history combined in a truly masterful way. Ahamed's firm grasp of the details involved quickly translates into a narration akin to story telling.

One drawback which may be raised against is the unnecessary biographical detail included of every character, which sometimes go backward to one or two generations prior to the person of note. At least at some points, the author is to be accused of inflating the content, especially the irrelevant detail of the menu of the six-course lunch at the second Dawes Conference. Apart from these, there is nothing which can be said against.

The wry humour exhibited throughout the book is very entertaining. When German mobs were dismissed forcibly by military police, "Even when shots were randomly fired near the palace, the fleeing crowds remained so instinctively law abiding that they obeyed the signs to keep off the grass" (p.101). The stock market boom in U.S. prompted many people to voice against the speculation in stocks. The author comments, "Watching other people become rich is not much fun, especially if they do it overnight and without any effort" (p.274). To stop bank runs, President Roosevelt closed all banks for a few days and we see "The residents of Michigan woke up on Saint Valentine's Day to find that all that they could draw upon was the cash in their pockets" (p.443).

Even though not related to the theme of the book, there is a side issue which is to be noted here. There is a concerted drive going on among the religious to establish that Hitler was an atheist, which he was not. The book describes a rally at Bad Harzburg by the Nazis in Oct 1931. "It was a reunion of everyone who was or had ever been against democracy in Germany. The town was festooned with banners in the old imperial colours. Aged generals and admirals from the previous war turned out. The event was kicked off by an invocation for divine guidance by a Lutheran pastor and a Catholic priest. The star of the occasion was Hitler, who hogged the spotlight with his impromptu speeches" (p.420).

The book is highly recommended.

Rating: 4 Star