Lords of Finance

by Liaquat Ahamed

  BUDGET DAY WAS until recently something of an occasion in the British parliamentary calendar. The event was traditionally surrounded with its own rituals—the buildup of suspense about the contents, the press speculation, the picture on the actual day of the chancellor emerging from No. 11 Downing Street, conspicuously brandishing the battered red dispatch box, the grand and excessively long speeches in Parliament about the minutiae of taxation and spending.28 It was, in short, a perfect opportunity for Churchill to display his talent for playing to the gallery.

  On April 28, he rose before the Commons at 4:00 p.m. to great applause. Everyone knew what he was about to say, but there were nevertheless tremendous cheers when, in the first few minutes of his speech, he announced the return to gold. Ever the showman, at one point during his two-hour speech, he paused, declaring, “It is imperative that I should fortify the revenue, and I shall now, with the permission of the Commons, proceed to do so,” and proceeded to pour himself a glass of “an amber-coloured liquid,” that from the press gallery appeared to be stronger than water.

  For all his ambivalence about the decision to return to gold, Churchill put on a great show. He seems to have been most swayed in his decision by the fear that not to return now would be seen as a very public admission of Britain’s diminished position in world affairs. Almost every other country was either now on gold—the United States, Germany, Sweden, Canada, Austria, and Hungary—or about to be—Holland, Australia, and South Africa—and “like ships in harbor whose gangways are joined together and who rise and fall together with the tide,” they were all linked by a common standard of value. As he would articulate a few days later in committee, “If the English pound is not to be the standard which everyone knows and trusts, the business not only of the British Empire but also of Europe as well might have to be transacted in dollars instead of pounds sterling. I think that would be a great misfortune.”

  While Churchill was speaking, Norman sat in the distinguished strangers’ gallery of the House of Commons, savoring what all London saw as his personal triumph. As Churchill himself would later put it, it was Norman’s “greatest achievement . . . the final step without which all those efforts and sufferings [that is, the years since 1920] would have gone for naught.”

  The decision was received with resounding applause both in the City and in the press, the Times commenting that it was “a signal triumph for those who have controlled and shaped our monetary policy, notably the Governor of the Bank.” The Economist described it as “the crowning achievement of Mr. Montagu Norman.” Only Beaverbrook’s chain of papers dissented.

  For a few months, McKenna’s ominous prediction proved to be wrong. The initial consequences of the move were relatively benign. Britain, with its higher interest rates, attracted enough money that the credits provided by the Federal Reserve and J. P. Morgan were never needed. Britain’s gold reserves actually increased during 1925.

  For Keynes, borrowing hot money from foreigners was only a way for Britain to buy time. In a three-part series of articles, initially published in late July in Beaverbrook’s Evening Standard, and later issued as a pamphlet, The Economic Consequences of Mr. Churchill, Keynes reminded his readers that Britain would have to “use the breathing space to effect what are euphemistically called the ‘fundamental adjustments’” in the economic life of the nation. At its new exchange rate, the pound was overvalued by more than 10 percent. To remedy this would require cuts in wages and prices across the economy that could be achieved “in no other way than by the deliberate intensification of unemployment” through a policy of tight credit and higher interest rates. It seemed perverse to him to institute a regime of credit restrictions at a time when unemployment stood already above one million. “The proper object of dear money is to check an incipient boom. Woe to those whose faith leads them to use it to aggravate a depression!”

  Though Keynes could not resist a typically malicious poke at Churchill—“because he has no instinctive judgment to prevent him from making mistakes . . . [and] because, lacking this instinctive judgment he was deafened by the clamorous voices of conventional finance”—the pamphlet was more an attack on the Bank of England and the Treasury.

  Certainly, Churchill seems to have seen it that way. In 1927, he invited Keynes to become a member of The Other Club, a private and highly exclusive dining society started by him and Birkenhead in 1911. Its members, restricted to no more than fifty, had to be both “estimable and entertaining.” It had twelve rules, which were read aloud at the beginning of each meeting, held every alternate Thursday while Parliament was in session. Churchill and Birkenhead determined who was to be invited to join. Rule 12 read, “Nothing in the rules or intercourse of the Club shall interfere with the rancour or asperity of party politics.” Its members read like a Who’s Who of British history between the wars and included all of Churchill’s pals—Birkenhead, Beaverbrook, and Bracken—but also such diverse figures as Lord Jellicoe, H. G. Wells, Arnold Bennett, P. G. Wodehouse, and Edwin Lutyens.

  By the late summer, the rise in the exchange rate began taking its toll on the staple export industries of coal, steel, and shipbuilding. Particularly hard hit was the weakest of these, coal, much of which was threatened with bankruptcy after the resumption of production in the Ruhr and the squeeze on prices from the rise in the exchange rate. The owners demanded a cut in wages and an increase in hours from the coal miners. In The Economic Consequences of Mr. Churchill, Keynes had railed against the social injustice of a policy where miners were being asked to be “the victims of the economic Juggernaut.” They were representatives “in the flesh [of] the fundamental adjustments engineered by the Treasury and the Bank of England to satisfy impatience of the City fathers to bridge the moderate gap between $4.40 and $4.86.”

  A national strike was averted only when the government at the last minute agreed to give the coal industry a massive subsidy of over $100 million. But this could only be a stopgap measure. By 1926, attempts to cut costs led to a long and bitter strike in the coal industry, and in May 1926, boiled over into a countrywide ten-day general strike. That this did not lead to a flight of capital from Britain and a crisis in the exchange market was only because the underlying weakness of Britain’s international position was masked by continued inflows of capital taking advantage of high interest rates in the London market and escaping the escalating crisis in France.

  The return to gold proved to be a costly error. That the money attracted by the high interest rates was speculative—“hot”—and not a source of permanent investment left a constant threat hanging over the currency. Just to prevent it from flooding back out again, interest rates had to be kept significantly higher than that in other countries for the balance of the decade. With prices falling at around 5 percent per annum, the burden of these charges on borrowers was heavy. Meanwhile, British manufacturing, hobbled in world markets by its high prices, limped painfully along for the next few years while elsewhere in the world industry boomed.

  Though Churchill remained chancellor until 1929, by 1927 he had come to realize that the return to gold at the old prewar exchange rate had been a misjudgment. But by then there was little he could do about it except fulminate in private about the evil effects of the gold standard. In later life, he would claim that it was “the biggest blunder in his life.” He blamed it on the bad advice he had received. In an unpublished draft of his memoirs, he wrote that he had been “misled by the Governor of the Bank of England [and] by the experts of the Treasury. . . . I had no special comprehension of the currency problem and therefore fell into the hands of the experts, as I never did later where military matters were concerned.” He reserved his greatest venom for Norman. It took only the slightest provocation for him to begin to rant on about “that man Skinner,” as he disparagingly referred to the governor. In a cabinet meeting in June 1928, one of his colleagues remembered him “to everyone’s surprise exploding on Montagu Norman and deflation.”

  In his speech before Parliame
nt during the debate on the Gold Standard Bill, Churchill had claimed that the move would “shackle Britain to reality.” And a shackle it did prove to be, but not so much to reality as to an outmoded way of thinking and to a hopelessly obsolete mechanism for controlling the international finances of the country. As Keynes had written in May 1925:The gold standard party have had behind them much that is not only respectable but worthy of respect. The state of mind that likes to stick to the straight old-fashioned course, rather regardless of the pleasure or the pain . . . is not to be despised. . . . Like other orthodoxies it stands for what is jejeune and intellectually sterile; and since it has prejudice on its side, it can use claptrap with impunity.

  The most damaging consequence was that in a futile attempt to retain the primacy of the Bank of England and the City of London, Britain had now tied itself irretrievably to the United States. During Norman’s visit to New York in January 1925, Strong had warned him, “In a new country such as ours with an enthusiastic, energetic and optimistic population, where enterprise at times was highly stimulated and returns upon capital much greater than in other countries, there would be times when speculative tendencies would make it necessary for the Federal Reserve Banks to exercise restraint by increased discount rates, and possibly rather high money rates in the market. Should such times arise, domestic considerations would likely outweigh foreign sympathies.” Norman cannot have realized how prescient those words were and how cruelly one day they would come back to haunt him.

  13. LA BATAILLE

  FRANCE: 1926

  Only peril can bring the French together. One can’t impose unity out of the blue on a country that has 265 different kinds of cheese.

  —CHARLES De GAULLE

  April 1925 might have been a good month for Governor Norman and the Bank of England, but in Paris, Governor Georges Robineau and the Banque de France were being simultaneously vilified and mocked in the press. Earlier that month, the French public had learned that for the past year, senior officials at the French central bank had conspired with their opposite numbers at the French treasury to cook the Banque’s books.

  The deception had begun as far back as March 1924. The government, finding it difficult to attract new buyers for its short-term debt, was forced to ask the Banque for an advance to cover some of its maturing bonds. But the amount of currency that the Banque could issue was limited by law and, in the embattled climate of the time, the government did not wish to face the political embarrassment of asking the National Assembly to raise the ceiling. Obliging officials at the Banque had found a way of issuing extra currency but disguising the fact with an accounting ruse, at first a technical, almost trivial adjustment, which no doubt those involved thought a temporary and justifiable expedient. But the scope of the operation had progressively grown and by April 1925, the “fake balances”—les faux bilans —amounted to some 2 billion francs, equivalent to 5 percent of the currency in circulation.

  Strong, Strong’s daughter Katherine, and Norman at Biarritz, 1925

  The doctored accounts were first discovered in October 1924 by the Banque’s deputy governor, who promptly informed Governor Robineau; the minister of finance, Étienne Clémentel; and the prime minister, Édouard Herriot. Although the governor kept pressing the government to correct the situation by repaying the Banque some of what it owed, the ministers vacillated and did nothing for six months, hoping against hope that public finances might turn around. When news of the falsified statements finally leaked out, the government was forced to go to the National Assembly to ask for an increase in the legal limit. Though the nationalist press called for the prosecution of Governor Robineau, he managed to hang on to his job because at least he had resisted the ensuing cover-up; but the humiliated government fell to a vote of no confidence after a debate in the Senate that was unusually bitter even by the rancorous standards of French political discourse of the time.

  The drama hit the headlines at a particularly sensitive moment. France was finally beginning to get its finances in order. The reconstruction of the war-ravaged departments of northeastern France had cost a total of $4 billion, but was now largely complete and the budget deficit had been cut from the equivalent of $1 billion in 1923, over 10 percent of GDP, to under $50 million, less than 0.5 percent. After the Dawes Plan, the government had also become much more realistic in its budgeting of how much it could truly hope to recover in reparations. And since the war, the Banque had been firm about restricting government borrowing from it. The currency ceiling of 41 billion francs established in 1920, a powerful symbol of the Banque’s independence, had been scrupulously respected for four whole years.

  But French finances balanced on a knife-edge. A large part of the public debt was short-term in nature, which made its refinancing an annual ordeal for the franc as French savers underwent an agonizing reappraisal of their government’s solvency. The fact that the Banque de France, of all institutions, should now have fallen from grace and was implicated in this sordid scandal, albeit one in which no individual seemed to have profited financially, provoked a minor crisis of confidence among French investors.

  For MUCH of the nineteenth century, the Banque de France had been by far the most conservative financial institution in all Europe, far more cautious, for example, than its cousin the Bank of England. Although it was not legally bound, as was the English central bank, to hold a minimum amount of gold, it had adopted the practice of retaining an unusually large gold reserve to back its currency notes—in 1914, the largest in Europe, totaling over $1 billion. On a number of occasions it had even been asked to come to the aid of the Bank of England—for example, during the crises of 1825 and 1837; in 1890, when Barings Brothers faced bankruptcy over its ill-considered loans in South America, and finally, during the panic of 1907. In effect, the Banque played the role of backstop to the Bank of England.

  While the Bank of England was a solidly bourgeois institution, egalitarian in the way that an exclusive men’s club is democratic among its members, the Banque de France was from its birth an aristocratic place, even if the aristocracy was only a few years old. Among its first few governors were the comte Jaubert, the comte de Gaudin, the duc de Gaete, the comte Apollinaire d’Argout, and the baron Davillier. Even after 1875, when the republic was brought into being for the third and final time and the French aristocracy abandoned political life, the Banque de France continued to be a haven for the nobility.

  The Banque itself remained a private institution owned by shareholders. Though the governor and deputy governors by this time tended to be drawn from the ranks of the higher civil service, they were still ultimately responsible to the twelve-man Council of Regents. In addition, the governor, though appointed by the government, was also required to own one hundred shares, which in the 1920s cost the franc equivalent of $100,000. Since few government officials, even the very highest, had that much free capital, the purchase money was lent by the regents, making the average governor very much their agent.

  In 1811, the Banque moved into the magnificently flamboyant Hôtel de la Vrillière, just north of the Louvre near the Palais Royal. It had once been the town palace of the comte de Toulouse, bastard son of Louis XIV and Madame de Maintenon. Every year at 12:30 in the afternoon, on the last Thursday of January, the pinnacle of French society would gather there for the Banque’s Annual General Assembly. Though it had more than forty thousand shareholders, only the top two hundred were eligible to attend the meeting and choose the regents. The conclave was held in the Galerie Dorée, the long rococo hall running down the center of the hotel. There, beneath the gorgeous paintings on the vaulted ceiling, the carved and sumptuously gilded woodwork, the opulent wall mirrors, seated in alphabetical order would be some of the oldest and most aristocratic families in France: Clérel de Tocqueville, La Rochefoucauld, Noailles, Talleyrand-Périgord.

  To be invited to this gathering was one of the most highly coveted emblems of social standing in France. Noblemen, who might otherwise care nothing abou
t banking, treasured their family holdings in the Banque, valued typically at several hundred thousand francs, equivalent then to about a hundred thousand dollars, and held for generations as a prized part of their patrimony.

  With an electorate of two hundred of the richest and grandest families in France, it was not surprising that seats on the Council of Regents came to be almost hereditary. Five out of the twelve elected regents were descendants of the original founders and a disproportionately large number were Protestants of Swiss extraction. In 1926, the twelve included Baron Ernest Mallet, Baron Édouard de Rothschild, Baron Jean de Neuflize, Baron Maurice Davillier, M. Felix Vernes, and M. François de Wendel. The Mallet family, Protestant bankers originally from Geneva, proprietors of a concern bearing their name, had the distinction of having sat on the council continuously for four generations, since it was first convened in 1800. The Rothschilds, the only Jewish family on the council, had sat there since 1855, when Baron Alphonse de Rothschild, managing partner of Rothschild Frères, the French arm of the banking empire, had been chosen. On his death in 1905, his seat had been passed to his son Baron Édouard.

  The Davilliers, like so many other regent families elevated to the baronage under Napoléon, were primarily industrialists, although they also operated an eponymous private bank. Baron Maurice Davillier was the fourth member of his family to serve on the council. Although Baron Jean de Neuflize was the first member of his clan to be elected, the Neuflizes, who owned one more eponymous bank, had been ennobled by Louis XV. Baron Jean, an avid sportsman who had represented France as an equestrian at the 1900 Olympics, was president of the Society of Steeplechasers and the even more exclusive Casting Club of France; his daughter was married to the wonderfully named English grandee Vere Brabazon Ponsonby, ninth Earl of Bessborough.