The 1930s Revisited

After all the publicity that it has already generated by being chosen as the FT/Goldman Sachs business book of the year, it may seem redundant to heap more praise on Liaqat Ahamed’s book Lords of Finance, which tells the story of how the four most important central bankers of the day struggled – and ultimately failed – to prevent the financial and economic crises that culminated in the Great Depression of the 1930s.

Yet it seems to me that the study of financial history remains so central to the achievement of investment success that further mentions of this outstanding work are not only defensible, but necessary. Lords of Finance is a splendid illustration of the value of historical narrative in throwing light on the complex and dynamic factors that shape the economic and financial environment, and provide an important perspective on the current outlook for equity, bond and currency markets.

In investment, so much good financial history has appeared recently that one has to hope the study of history, and other thriving disciplines such as psychology and behavioural science, will create a better understanding of the roots of market behaviour. This follows a period in which misguided reliance on quantitative techniques and simplistic, unprovable theorems has by common consent contributed to the unprecedented financial traumas of the past two years.

In the evolution of the global financial crisis, central bankers have played a central role, which makes Mr Ahamed’s book, although it was largely completed before the collapse of Lehman Brothers, timely. A year on, the parallels between the issues facing the four central bankers who are central to his story (Montagu Norman at the Bank of England, Benjamin Strong of the New York Fed, Emile Moreau at the Banque de France and Hjalmar Schacht of the Reichsbank) and those facing their counterparts today are all too obvious.

One of the strengths of Lords of Finance is that it demonstrates that central bankers have never been the heroic figures of omniscient authority that Alan Greenspan was for some years, absurdly, depicted as being. It is true that in the 1920s none of the central banks in the US, Britain, Germany and France had the experience, let alone the powers, that they enjoy today. The Federal Reserve, founded in 1913, took years to find its feet, its early years memorably described by J.K. Galbraith as “a body of startling incompetence”.

But in other ways the central bankers of the 1920s had a much easier time than their modern successors, who have to cope with media exposure and the infinitely greater complexities of modern globalised markets. Mr Ahamed has a particularly good eye for the telling anecdote about his protagonists, who include not only the central bankers and statesmen of the day, but other influential contemporaries, of which John Maynard Keynes inevitably commands the greatest attention.

This, for example, is Mr Keynes in June 1931, shortly before Britain finally abandoned the Gold Standard, the prop on which its policy had so stubbornly relied for too long: “We are today in the middle of the greatest catastrophe – due almost entirely to economic causes in the modern world. I am told the view is held in Moscow that this is the last, the culminating crisis of capitalism, and that our existing order of society will not survive it.”

There were some only months ago who felt something similar, although it is worth making the point that Mr Keynes had originally not been totally opposed to the Gold Standard before changing his mind as the 1920s unfolded. Those who today put forward Keynesian solutions from the 1930s rarely allow for the fact that he would almost certainly have had his own original ideas for resolving the current crisis, which might have been very different from the ones he expounded 70 years ago.

It is impressive too to learn of the British Ambassador’s superbly robust contemporary assessment of the German central bank’s disastrous monetary policies after the first world war, which paved the way for hyperinflation and the rise of Hitler. “No one could anticipate such an ingenious revelation of extreme folly to which ignorance and false theory could lead . . . The Reichsbank’s own demented inspirations gave stabilisation no chance . . . It appears almost impossible to hope for the recovery of a country where such things are possible”.

Mr Ahamed is rightly keen to stress that the lessons from a study of the Great Depression are not as simplistic as Milton Friedman and many others would have us believe. Nevertheless his conclusion is blunt: “The Great Depression was not some Act of God or the result of some deep-rooted contradictions of capitalism, but the direct result of a series of misjudgements by economic policy makers, some made back in the 1920s, others after the first crises set in – by any measure the most dramatic sequence of collective blunders ever made by financial officials.

“More than anything else, therefore, the Great Depression was caused by a failure of intellectual will, a lack of understanding about how the economy operated.”

Just as the boom of the later 1920s convinced the world that the fatally flawed Gold Standard regime might have created a new economic order, so we will surely look back on the years of the Great Moderation in time to come and conclude that it was another failure of intellectual will that sowed the seeds of our current problems. Nor, if history is any guide, are those troubles remotely over, however reassuring the government-sponsored market rally of the past nine months may be.