Lords of Finance

by Liaquat Ahamed

  War Debts

  Neither a borrower, nor a lender be; for loan oft loses both itself and friend.

  —WILLIAM SHAKESPEARE, Hamlet

  THE problem of collecting reparations from Germany was made infinitely more complex by that of war debts owed to the United States. Britain had gone to war as “the world’s banker,” controlling over $20 billion in foreign investments. No other financial center—neither Berlin nor Paris, certainly not New York—came close to matching London’s standing as the hub of international finance. Through it passed two-thirds of the trade credit that kept goods flowing around the globe and half the world’s long-term investments—over $500 million a year. Meanwhile, France, though never so dominant a financial power, had its own overseas portfolio of $9 billion, of which an astounding $5 billion was invested in Russia.

  To pay for the four long, destructive years just past, every country in Europe had tried to borrow as much as it could from wherever it could. The effect was to create a seismic shift in the flow of capital around the world. Both Britain and France were forced to liquidate a huge proportion of their holdings abroad to pay for essential imports of raw materials, and both eventually resorted to large-scale borrowing from the United States. By the end of the war, the European allied powers—sixteen countries in all—owed the United States about $12 billion, of which a little under $5 billion was due from Britain and $4 billion from France. In its own turn, Britain was owed some $11 billion by seventeen countries, $3 billion of it by France and $2.5 billion by Russia, a debt essentially uncollectible after the Bolshevik revolution.

  At an early stage of the Paris Peace Conference, both the British and the French tried to link reparations to their war debts, indicating that they might be prepared to moderate their demands for reparations if the United States would forgive some of what they owed America. The United States reacted strongly, insisting that the two issues were separate. Its delegates, many of them lawyers, including the secretary of state, Robert Lansing, made a clear moral and legal distinction between reparations, which resembled a fine and were intended to be punitive, and war debts, which were contractual liabilities voluntarily entered into by the European Allies. The Europeans, less wedded to legal modes of thought, failed to see either the moral or the practical distinction between their obligations to the United States and Germany’s obligations to them. Both would be burdensome and both would require material sacrifice for several generations.

  As the Peace Conference was winding to its end, Maynard Keynes, distressed at how the negotiations were going, decided on his own initiative to put together a comprehensive plan for the financial reconstruction of Europe. Reparations should be fixed at $5 billion, to be paid by Germany in the form of long-term bonds issued to the Allies, which they would in turn assign to pay their war debts to the U.S government. All other obligations were to be forgiven. It was a clever scheme. The U.S. government would be functionally lending Germany money, which in turn would go to pay reparations to the Allies, who in turn would use those proceeds to settle their loans. The money would start in a United States flush with gold, and eventually return there full circle.

  Keynes passed the plan on to the chancellor of the exchequer, Austen Chamberlain, who in turn recommended it to Lloyd George. The prime minister received Keynes’s plan just as he was beginning to realize the extent of his tactical errors over reparations and, in a short burst of enthusiasm, submitted it to President Wilson. It was rejected out of hand by the American delegates, who continued to insist that war debts must not be linked to reparations and that the former could not be forgiven on such a scale. And thus the problem of reparations and war debts would be allowed to fester over the maimed economic body of Europe.

  TEN DAYS AFTER the armistice of November 11, 1918, Benjamin Strong wrote to Montagu Norman, “The principal danger now ahead of us . . . is not social and political unrest” but that the coming peace negotiations would “develop along lines of economic strife” that would lead to “a period of economic barbarism which will menace our prosperity.” “There is no doubt,” he continued, “that much of the world’s happiness in the future will depend upon the relations now being established between your country and ours.” Over the next decade that compact between Britain and the United States—or rather between the Bank of England and the Federal Reserve—built upon the friendship between Norman and Strong, would be one of the fixed points of the world’s financial architecture.

  The two of them came to that compact from very different directions. For Norman, it was a matter of simple necessity. The war had devastated Britain economically; and, he believed, only by acting in conjunction with the Americans could Britain hope to regain its old financial influence. For Strong, the calculation was a little more complicated. As a banker from the Morgan fold, he was naturally an internationalist. The war had brought a new recognition among U.S. financiers that the fate of their country was inextricably linked to that of Europe. Now, with the arrival of peace, he believed that it was in its own interest for the United States to use some of its huge resources to “help to rebuild a devastated Europe.”

  There was also a moral imperative to Strong’s internationalism. He was part of that generation of Americans who, having begun their careers under Theodore Roosevelt and having reached maturity under Woodrow Wilson, viewed themselves and their country as now uniquely qualified and positioned, by virtue of money and ideas, to transform the conduct of international affairs. He was, of course, not so naive that he did not recognize that many Europeans remained cynical about U.S. motives—accusing it, for example, of having deliberately waited until Europe had come close to bankruptcy before entering the war. He, however, was one of those who believed that now that the war was over, his nation had a unique opportunity to show that it was truly, in his own words, an unusually “unselfish, generous people.”

  He was especially influenced in his sense of high purpose about America’s world mission by a group of young men with whom he had become friends who went by the mysterious name “The Family.” Based in Washington, The Family was an exclusive private club, which he had been invited to join before the war. It had no official name, was indeed not really a club at all—no officers, no charter, no formal membership roll. It had come into being in 1902 when three young army officers, captains Frank McCoy, Sherwood Cheney, and James Logan, all in their early thirties, attracted to Washington by Theodore Roosevelt’s “call to youth,” decided to rent a house together at 1718 H Street. This soon became a gathering spot for ambitious young diplomats and service officers, all similarly inspired by Roosevelt’s vision of a muscular U.S. foreign policy. In the absence of a formal name, it came to be known as the 1718 Club or The Family.18

  The membership progressively widened to include a more eclectic circle, including journalists, such as Arthur Page, editor of the popular monthly The World ’s Work; politicians, like Congressman Andrew Peters, who would become mayor of Boston; and bankers, such as Strong. Over the years, though, The Family had remained an extraordinarily tight-knit group who kept in close touch with one another, particularly during the war. When the fighting finally stopped, many members found themselves thrown into the peace negotiations.

  No one was more emblematic of the ethos of The Family than Willard Straight, a flamboyant charmer whose life reads like something out of a boy’s adventure novel. Early orphaned, Straight had graduated from Cornell, gone out to China, where he learned Mandarin, served as a reporter during the Russo-Japanese war of 1904, become secretary to the American legation in Korea, been appointed consul general in Manchuria, and joined a Morgan-led bank in China, all by the age of thirty. Thereafter he had married an heiress, Dorothy Whitney; helped found the New Republic; seen army service in France; and with the armistice, joined the advance team in Paris to prepare for the forthcoming Peace Conference. Tragically, he contracted influenza during the 1918 pandemic and died suddenly in December 1918, at the age of thirty-eight.

  Another memb
er, Joseph Grew, had been in Germany as the number two in the embassy during the first years of the war, had gone on to become the State Department’s desk officer for Germany, and was now leading the advance team in Paris. William Phillips, who came from a rich family and had rejected a “pallid career” in business to become a career foreign service officer, became a Far Eastern specialist after assignment to Peking. Subsequently posted to London, he was now an assistant secretary of state. Another foreign service hand, Basil Miles, a particularly close friend of Strong’s, had taken his degree at Oxford, been posted to Petrograd in 1914, and was now State’s prime expert on Russia.

  James Logan, one of the founders of this dedicated brotherhood, had stayed in the army, rising to the rank of lieutenant colonel, and had been posted to France in 1914 as chief of the American observer military mission. An overweight bon viveur, he had become a fixture in Paris. Once the United States joined the war, he was given a high staff position in the American Expeditionary Force and was now working for Herbert Hoover in the Relief Administration.

  With so many fellow members of The Family in Paris in the war’s immediate aftermath, Strong decided that he should see for himself what needed to be done in Europe. But as happened so often over the next few years, his body gave out on him. Worn out by the demands of war finance, he suffered a minor recurrence of tuberculosis and was forced to take another leave of absence during the first few months of 1919.

  By the summer, he was back on his feet and ready to go to Europe. The Peace Conference had just finished, and as he left the United States the country was still in the full flush of jubilation and optimism over the signing of the peace treaty. Strong arrived in England on July 21, aboard R.M.S. Baltic, as Britain’s official peace celebrations were winding down. There had been parades and ceremonies across the country from the tiniest villages to the biggest cities. In London a million people had come out to watch a huge parade, including American and French contingents led by General John Joseph “Black Jack” Pershing and Marshal Ferdinand Foch, march past the king and queen and members of the government. The capital was still decked out with flags, and the troops who had taken part were still camped out in Kensington Gardens as Strong’s train rolled into the city.

  Although the statesmen in Paris had failed to come up with some grand initiative to reconstruct Europe, he arrived full of great expectations, still convinced, for all the failures of the treaty, that the United States would eventually adopt a “constructive policy towards the restoration of Europe,” by postponing the repayment of war debts and providing direct aid for reconstruction.

  For all the celebrations, he found the city’s mood ominously changed. In contrast to America, Britain was only slowly readjusting to peace. Tobacco restrictions had been removed in January and most food rationing in May. But bread was still obtainable only with ration coupons, as was sugar. The initial optimism, which had gripped Britain and all the European victors immediately after the war, was now wearing off as the grim realities of Britain’s underlying position were becoming steadily more apparent. The war had changed the balance of financial power, and Strong kept encountering a festering resentment against the United States, especially over war debts.

  Few people in those days thought in terms of a “special relationship” between Britain and the United States—indeed, the phrase was only coined in 1945 by Winston Churchill. Before the war, most London bankers viewed their counterparts in the United States with that superciliousness reserved for unsophisticated kinsmen, too rich for their own good. Within the United States, certain circles—the House of Morgan, the partners at Brown Brothers—were natural Anglophiles. Elsewhere, Britain was generally regarded with suspicion and cynicism. But during the war and after, British arrogance had given way to resentment. London bankers worried that the United States, with its newly acquired financial muscle, was getting ready to elbow its way into the role of banker to the world. During Strong’s visit to London in March 1916, he attended a speech made by Sir Edward Holden, chairman of the London City and Midland Bank, “in which [Sir Edward] referred to efforts of American bankers to undermine Lombard Street’s supremacy and . . . was so overcome by the mere thought that the old man broke down and wept.”

  Strong now found British bankers and politicians fervently convinced “that the Allies have made the greatest and most vital sacrifice in the war” while the U.S. sacrifices had “been slight, and our profits immense and that existence of this great debt is a sword of Damocles hanging over their heads.” There was considerable bitterness at how long the United States had sat out the war, many of Strong’s English acquaintances believing that America had deliberately waited for Europe to wear itself out before stepping in to pick up the pieces. Now those same people argued that the U.S. government was morally obliged to forgive part of their European Allies’ war debts. This was especially true in Britain, which had borrowed some $5 billion from the United States but had itself lent $11 billion to France, Russia, and other countries—in effect, simply acting as a conduit for the loans. And though his friend Norman tried to reassure him that people were allowing “their hearts to rule their heads,” that Britain’s credit was still strong, and that it was still good for its debts, Strong was undoubtedly shaken by the pessimism that hung over the City of London.

  Not only had Britain’s place in the world changed, but British society had also been transformed by the war. The aristocracy that had ruled Britain for much of the previous century had been badly damaged—as one contemporary author wrote, albeit with some exaggeration, “In the useless slaughter of the Guards on the Somme, or of the Rifle Brigade in Hooge Wood, half the great families, heirs of large estates and wealth, perished without a cry.” After enduring savage losses in the fighting—the casualty rate had been three times heavier among junior officers, many of them aristocrats, than among enlisted men—the old elite had also been hurt by the wartime inflation and was now being decimated by postwar economic dislocations. Land prices had collapsed and many large estates been put up for auction. In place of the old and confident ruling class, a whole new breed—“hard-faced men who had looked as if they had done well out of the war,” as one eminent politician described his new colleagues in the House of Commons—had come to power.

  At the end of July, Strong went on to Paris and, for the next few weeks, used the Ritz Hotel on the Place Vendome as his base while traveling around Europe. He visited Brussels—liberated only a few months before—Antwerp, and Amsterdam, establishing connections with the heads of European central banks but also taking a melancholy motoring trip through the giant cemeteries of the Western Front.

  The view from Paris was even more foreboding than from London. The city was dark by 10:00 p.m. for want of coal to generate electricity. The Peace Conference was still officially in session, limping through the final negotiations with the smaller Central Powers and successor states: Austria, Hungary, Bulgaria, and Turkey. But the big delegations had all departed and with them the accompanying train of ten thousand other assorted people: the advisers, the wives, the mistresses, the cooks, drivers, messengers, secretaries, and journalists. The hotels had reverted to their normal business—at the end of July, the Majestic, headquarters of the British delegation during the conference, and the Crillon, that of the American delegation, both reopened for commercial business. The radical journalist Lincoln Steffens, who had come to Paris with the American delegation and stayed on after the conference, best captured the city’s bitter mood of disillusionment during those months, “The consequences of the peace were visible from Paris. There were wars, revolutions, distress everywhere.”

  Over the summer, the political threats to Europe had actually begun to recede. Though civil war still ravaged Russia, the risk of Bolshevik revolution in Germany had diminished. A Communist uprising in Berlin and an attempted revolution in Bavaria had both been crushed. From Strong’s point of view, the main danger was now economic. The two largest countries, France and Germany, both urgent
ly needed food from abroad. Continental Europe was desperately short of capital to rebuild itself. Most disturbingly, he found a complete “lack of leadership” in Europe, with “people in authority . . . exhausted.”

  While Strong was in Paris, it became apparent that the United States was beginning its retreat from European affairs. The peace treaty had run into trouble in the Senate and seemed headed for defeat. Though the president had announced his intention to appeal directly to the people, the mood of the country was clearly turning isolationist.

  Strong could not hide his disgust at this betrayal. At the end of August he warned Russell Leffingwell, undersecretary of the treasury and soon to be a Morgan partner, that if the United States were to “desert Europe and leave these new governments to their fate,” this could only result in “prolonged disorder and suffering. It would be an act of cowardice for which we would be despised.” He returned to the United States in late September. A few days before, on September 25, the president had collapsed with a stroke on his western campaign to drum up support for the treaty, and for the next year was to lie incapacitated in the White House. On November 19 the Senate rejected the treaty by a vote of 55 to 39.

  As so often seemed to happen when he got back from Europe, Strong suffered yet another relapse of his tuberculosis. The doctors again insisted that he take a leave of absence, and the directors of the New York Fed released him for a year. Initially he went out to Arizona for the elevation and dry climate and by the following spring seemed well on the way to recovery. In March he set off on horseback across the Arizona desert accompanied by an unusual troop of companions: a mule skinner cum cook; a Pima Indian guide cum horse wrangler whose name was either Frank, Francisco, Pancho, or Juan—no one was quite sure which—a Russian wolfhound named Peter; and Strong’s old friend from The Family, Basil Miles. As this entourage trekked across the wilderness, breathing “the most wonderful air,” seeing “the most gorgeous sunsets,” and sleeping under the stars, the problems of European reconstruction and currency chaos must have seemed far away.