Tower of Basel: The Shadowy History of the Secret Bank that Runs the World

by Adam LeBor

  BY THE MID-1980S, the controversy over the Tower of Basel had faded away. The sleek, modernist building, looming over Centralbahnplatz, had become part of the Swiss city’s urban skyline. The circular tower block, pointing skyward, symbolized the bank’s new reach and ever more ambitious aspirations. The bank had shown a protean ability not just to survive but to flourish in rapidly changing circumstances. The ostensible reason for the BIS’s foundation—the management of German reparations payments for the First World War—was now a fading memory. So was the Bretton Woods conference, where Henry Morgenthau and Harry Dexter White had tried to have the bank closed down. The financial system designed there, which fixed the price of gold at $35 an ounce was also gone, ended by President Nixon in 1971.

  But the BIS now stood at the center of the global financial system. Leutwiler, the BIS president, had saved the Hungarian economy with a telephone call and accelerated the process of political reform that would eventually bring down Communism. The bank was managing multiple bailout packages that were easing the Latin American debt crisis and so preventing a potential catastrophic run on American banks. Some banks however, could not be rescued. There, too, the BIS positioned itself at the center of events. In 1974 the Franklin National Bank in New York and the Bankhaus Herstatt in Germany went bust after overextending themselves. At the time, Franklin was the biggest American bank in history to fail. Herstatt was a much smaller private bank but did substantial foreign exchange business in the United States. In response the BIS and the G10 governors set up the Basel Committee on Banking Supervision to begin the long, complicated, and still ongoing process of regulating commercial banks. The committee, naturally, was based at the BIS, from where it operates to this day. By hosting and providing secretarial and administrative services to new transnational financial groupings, such as the EEC Governors’ Committee and the Basel Committee on Banking Supervision, the bank was steadily making itself indispensable for the functioning of the global economy. The committees’ location in the Tower of Basel brought prestige, a stream of admiring visitors and dignitaries, and a new sense of permanence. There were no modern equivalents of Henry Morgenthau or Harry Dexter White, demanding that the BIS be closed down.

  The BIS was also surprisingly nimble. The bank had been an early adopter of computer technology and its ultrasecure databases, which were hosted in the tower, were fast becoming the essential reference store for information on central banks and cross-border banking transactions. Some of that information was collated in the bank’s annual reports that were ever more informative and had become required reading in the world’s treasuries, finance ministries, and trading houses. The 58th Annual Report, published in June 1988, was 223 pages long. Its eight lengthy, detailed sections included the bank’s analyses of general economic developments, international trade and payments, domestic and international financial markets, monetary policy, the international monetary system, and the BIS’s own banking activities. These were increasingly lucrative. The accounts for the year ending March 31, 1988, showed a net tax-free profit of almost 96 million Swiss gold francs, an increase of almost five million more than the previous year.

  Tucked away on pages 197 and 198, under the report of the bank’s functions as agent, trustee, and depositary, and written in a banker’s dry prose, were telling details that highlighted the BIS’s central and vital role in the European integration project. Behind the scenes, the BIS continued to provide the financial expertise and technical assistance for the most significant economic development in postwar history: the drive toward European union. From the secret wartime discussions between Per Jacobssen, the bank’s economic adviser, and Emil Puhl, the BIS director and Reichsbank vice president, to the detailed plans for the implementation of European Monetary Union in the late 1980s, the BIS played a driving role at every stage.

  The BIS managed the 1947 Paris agreement on multilateral payments. Three years later the accord grew into the European Payments Union and the BIS was appointed the new system’s agent. When European currencies became convertible, the EPU became the European Monetary Agreement that was managed, naturally, by the BIS. The BIS was deeply entwined with the European Coal and Steel Community, the first supranational European organization. It had signed an Act of Pledge with the ECSC in 1954 and subsequently handled all the loans issued by the ECSC. The BIS imprimatur gave the fledging organization vital credibility on international markets. The last ECSC loan had been redeemed in 1985–1986, and all unused funds had been returned to the European Commission in Luxembourg, the bank’s 1988 annual report noted.

  The BIS had hosted the Committee of Governors of European Economic Community Central Banks since it first met in 1964 and provided its secretariat. The EEC Governors’ Committee coordinated and integrated the monetary policies of its members, a precursor to eventual European economic union. The committee was independent of the BIS, but its members later included Alexandre Lamfalussy, the bank’s general manager from 1985 to 1993. The committee managed the first limits on exchange rate fluctuations within European currencies, a mechanism known as the “Snake in the Tunnel,” which was an important step toward European monetary union.

  The EEC Governors’ Committee was significant, said Richard Hall, the former assistant general manager of the BIS. “The discussions in the European Economic Community were intergovernmental and central bankers were always number two to ministers. But the central bankers had been coming to Basel for many years, before monetary union was discussed. They were accustomed to talking together and doing things together and they did not want to be upstaged by finance ministers. They were already in Basel once a month for the BIS meetings, so they set up the committee there and the bank was very happy for them to do that.”10

  The BIS was the agent for the European Monetary Cooperation Fund, which had been set up by the Committee of Governors to manage short-term credit arrangements for members of the European Economic Community, the predecessor of the European Union. The bank was also the agent for the clearing and settlement system for the European Currency Unit (ECU) that was the precursor of the euro.

  The establishment of the European Coal and Steel Community and its evolution into the European Economic Community were presented as an unmitigated boon for the countries concerned. But the most dramatic and far-reaching peaceful re-ordering of Europe in modern times—the steady and relentless erosion of national sovereignty—was implemented by sleight of hand. The key, for both the European project and the ever-broader mandate of the BIS, was to present decisions, policies, and actions as “technical” and “apolitical,” of no concern to the average informed citizen. In fact, the opposite was true. There could hardly be anything more political than the handing over of national powers to unelected supranational bodies, while the necessary financial mechanisms were arranged and managed by a secretive and completely unaccountable bank in Basel.

  By the late 1980s this process was effectively unstoppable. In the summer of 1988 the EEC central bank governors were asked to serve, in their personal capacity (so that they would not be seen as representing their national banks), on the Committee for the Study of Economic and Monetary Union (EMU), which prepared for the adoption of a single European currency, the euro. The committee was better known by the name of its chairman, Jacques Delors, a French civil servant and politician.11 Delors was president of the European Commission, which oversees the implementation of European laws and policies.

  The Delors Committee had seventeen members, including Karl Otto Pöhl, the president of the Bundesbank; Robin Leigh-Pemberton, the governor of the Bank of England; and Willem Duisenberg, the president of the Netherland National Bank, all of whom were board members of the BIS. The questions of how, when, and even if EMU should be carried out were left to the politicians. The committee was concerned with the technical aspects, rather than the political implications. Once again, the BIS was at the center of events. The Delors Committee did not meet in Brussels, the site of the European Commission, or Strasbou
rg, the home of the European Parliament, or Frankfurt. It set up shop in Basel. There it enjoyed its own dedicated support staff, supplied by the BIS.

  Behind the scenes, one of its most influential members was Alexandre Lamfalussy, the Hungarian-born BIS general manager. Lamfalussy had fled his homeland after the Soviet takeover in the late 1940s. He moved to Belgium and taught at the Catholic University of Louvain and later at Yale. Lamfalussy joined the BIS in 1976 as economic adviser, the post once held by Per Jacobssen. In 1985 he was appointed general manager. Lamfalussy was widely regarded as the intellectual powerhouse behind European economic integration and, from the project’s earliest beginnings, had a deep grasp of both its practical operation and theoretical underpinning. When the Snake, the fixed-limit exchange rate mechanism, had run into trouble, for example, the governors had turned to Lamfalussy for advice.

  So it was only natural that the Delors Committee would frequently defer to Lamfalussy’s opinions, all of which greatly annoyed European officials visiting from Brussels. They could not understand why the great European monetary integration project was being directed from a suite of rooms in a tower block by Basel central railway station, which was out of their political and legal jurisdiction. But Delors’s primary concern was not the prickly Eurocrats, but the central bankers. He understood that without them EMU could not take place. “It was the genius of Delors, who was a great manipulator—in the good sense of the term—who realized that he absolutely did not want to and would not hurt the feelings of the governors of the central bank,” Lamfalussy recalled.12 Logistics also played a role. Many of the Delors Committee’s most important members, such as Pöhl and Leigh-Pemberton, already came to Basel for the governors’ meetings. There, at the Sunday evening G10 governors’ dinner, the central bankers decided what Lamfalussy described as the “norms of cooperation,” in circumstances as secretive as ever. “This was the dinner where we talked about the most difficult issues, with no notes or anything.”13

  The Delors Committee also had two rapporteurs: Gunter Baer and Tomasso Padoa-Schioppa. Baer had worked as an economist at the BIS. Padoa-Schioppa was an Italian economist who is considered one of the intellectual founding fathers of the euro. The rapporteurs were immensely influential. They prepared the meetings, wrote reports, and “held the fountain pen,” as Lamfalussy put it. “It was my officials that prepared the meetings in Basel of a project that was primarily European.”14

  The Delors Committee presented its report on EMU in April 1989. Central banks’ reserves would be off limits to governments. Borrowing in non–European Community currencies should be limited. There would be sanctions against countries that exceeded a budget deficit threshold (currently three percent). Crucially, the sanctions would apply not just to members of the future Eurozone, but to all European Union member states. The report called for European countries to take substantial steps toward economic convergence, budgetary discipline, and price stability, before moving decisively toward economic and monetary union.

  However it was unclear how this strict, common financial discipline would be imposed. A common monetary policy, based on a shared currency, demanded a common fiscal policy with shared rules for government taxation and spending, Lamfalussy argued in a memo in January 1989, but there were no plans for this:

  In short, it would seem to me very strange if we did not insist on the need to make appropriate arrangements that would allow the gradual emergence, and the full operation once the EMU is completed, of a Community-wide macroeconomic fiscal policy which would be the natural complement to the common monetary policy of the Community.15

  As Harold James notes, Lamfalussy’s memo was both “apposite and intellectually compelling.”16 It neatly summarized the contradiction of a transnational currency with no transnational fiscal policy—a contradiction that remains unresolved and has both triggered and fueled the Eurozone crisis. The following month, Lamfalussy, during a discussion of the kind of controlling and supervisory budgetary methods needed for EMU, even suggested adding the word “enforceable” to the final draft. His suggestion was not incorporated into the report. Nonetheless, even without a common fiscal policy, Lamfalussy argued that Europe must press ahead with monetary union, if only because the European Monetary System (EMS), which limited exchange rate variations, had fallen victim to the law of unintended consequences. The system intended to stabilize currencies was having the opposite effect.

  Speculators were pouring money into Italy. There inflation in 1988 was around five percent, compared to Germany at 1.3 percent. High inflation meant higher interest rates, but as the lira was locked into the EMS, its value was guaranteed. For investors there was no downside. The liberalization of capital movements had accelerated this process. The EMS was vulnerable, argued Lamfalussy and Europe must move to EMU as soon as possible. “It is for this reason that I would be in favor of a first stage that could be implemented as quickly as possible and not in a two or three year distant future, but starting this autumn or at least at the end of the year.”17

  The Delors Report, as it became known, was forty-three pages long. It was accompanied by a collection of fifteen papers which were written by the members of the committee. The influence of the BIS was clear. Jacques Delors wrote two of the papers, the first with the kind of grandiose title beloved of French politicians: “Economic and Monetary Union and Re-launching the Construction of Europe.” Three papers were written by Alexandre Lamfalussy. Lamfalussy’s articles dealt with some of the most important technical aspects of the process of monetary and economic union: the macro-coordination of fiscal policies in an economic and monetary union; the European Currency Unit banking market; and a proposal for centralizing monetary policy.

  Back in the 1920s, Norman had mused to Benjamin Strong, the chairman of the New York Federal Reserve, about the need for a “private and eclectic Central banks’ club, small at first, large in the future.” When Norman had summoned Walter Layton, the editor of The Economist, to his office to ask him to draft the bank’s statutes, he had emphasized that they must, above all, guarantee the BIS’s independence. The Delors Report confirmed that crucial principle. Governments would be excluded from monetary policy making. The Delors report called for the creation of a new institution to centrally decide and coordinate member states’ monetary policy operations, to be called the European System of Central Banks (ESCB). Montagu Norman may not have approved of a Europe-wide currency, but he would certainly have applauded the report’s demand that the ESCB must be completely independent from both national governments and European authorities.

  The Delors Report’s recommendations that the European Union should adopt a single currency and a unified monetary policy were accepted. The momentum toward monetary, economic, and political union was unstoppable. A new bank, the most powerful institution within the ESCB, would be created to define and implement monetary policy. The European Central Bank’s primary task would be to ensure price stability while remaining free of all political pressures. It sounded all too familiar.

  PART THREE: MELTDOWN

  CHAPTER FOURTEEN

  THE SECOND TOWER

  “European economic unity will come, for its time is here.”

  — Walther Funk, 19421

  The Reichsbank president and BIS director was half right. European economic unity did indeed arrive, but it came sixty years after he predicted. Walther Funk lived to see two of the most important early milestones: the establishment in 1951 of the European Coal and Steel Community, Europe’s first supranational institution, whose loans were managed by the BIS, and the signing of the Treaty of Rome in 1957, when the six core countries—Germany, France, Italy, Belgium, Luxembourg, and the Netherlands—established the European Economic Community.

  Funk was released from Spandau Prison in Berlin the same year and died in 1960, but his pan-European plan for a continent free of trade and currency restrictions lived on and flourished. A European customs union came into existence in 1968. Just over a decade later, i
n 1979, Europeans voted in the first elections for the European Parliament. In 1992 twelve European countries signed the Maastricht Treaty, which brought the European Union into existence. On January 1, 1993, the European single market began operating across the twelve member states of the European Union. Its citizens could live and work freely wherever they wanted, companies could sell their products, and currencies and capital flowed unhindered.

  Funk would certainly have applauded. The Nazi economics minister had raised the idea of European monetary union as early as 1940, to be introduced incrementally by harmonizing currency fluctuations and constraining exchange rates, as indeed happened.

  To point out any similarities between the Nazis’ postwar economic plans for Europe and today’s European Union is to risk ridicule and invective. The European integration project, has, for many, become an untouchable truth, an article of faith in the world’s inexorable progress toward a brighter and more secure future. Certainly, European integration has many achievements to its credit: speeding up reconstruction after 1945; opening the continent for free trade and nurturing a new generation of pan-Europeans who think beyond national borders. By incorporating the shaky democracies of post–Communist Europe the European Union has helped stabilize the eastern half of the continent. The oft-stated values of the European Union: human rights, democracy, and protection of minorities are the very antithesis of the Third’s Reich’s ideology.