The
Mother of all Financial Crises
This is a book for economic history nerds, not for the
typical lay reader. Danish business school professor Per Hansen takes us deep
into the financial crisis of 1931 starting in May when the Credit Anstalt Bank
of Vienna collapsed and ending in October in the aftermath of England going off
the gold standard. Although the crisis has been covered before by Barry Eichengreen,
Peter Temin, Liaquat Ahamed and Tobias Straumann (See: Shulmaven:
My Amazon Review of Tobias Straumann's "1931:Debt, Crisis and the Rise of
Hitler" ), Hansen’s account is the most
detailed.
Instead of writing history after the fact, Hansen
takes us into the minds of four key players in the crisis as they try to make
sense of the enveloping collapse. His four players are Montague Norman,
Governor of the Bank of England; George Harrison, President of the New York
Fed; Francis Rodd, bank of England official on loan to the newly formed Bank
for International Settlements; and Harry Siepmann, Advisor to Norman. They all,
especially Rodd, took detailed notes. Hansen records many of them in full and
he had access to the numerous telegrams that lit up the wires of Europe.
For all four of them the maintenance of the gold standard
was the highest priority and as Eichengreen, Temin, and yes Keynes noted, it
was the fetters of the gold standard that worsened the crisis. Hansen calls out
the fact that the United States and France did not play by the rules of the
gold standard by failing to ease credit sufficiently to staunch the inflow of
gold coming from Germany and England. It was the gold outflow from Germany and
England that forced upon them a deflationary spiral from which there was no
recovery.
All four of them were operating under the lender of
last resort rules proposed by Walter Bagehot in 1873. (See: Shulmaven:
My Amazon Review of James Grant's "Bagehot: The Life and Times of the
Greatest Victorian" ) Bagehot’s
crisis rule called for central banks to lend freely, against good collateral at
a penalty rate. That works if there is sufficient good collateral to lend
against. In the case of Credit Anstalt, there was none. Indeed, Credit Anstalt
was more a private equity fund controlling about 70% of Austrian industry, than
a commercial bank. Simply put, it was funding long term equity with short term
deposits. When the market recognized the bank’s assets were worth far less than
was thought, a bank run ensued. What exacerbated the crisis was that Credit
Anstalt was a highly prestigious Rothschild bank with a blue-ribbon board of
directors. If it could happen to them, it could happen to any bank.
The crisis then moves to Germany in July when the
Danat Bank failed triggering an internal and external drain on deposits. In an
effort to maintain the gold standard, the Bruening government yet again adopts
further austerity policies as a condition to receiving aid from the Bank of
England, the Bank of
France and the New York Fed. Yes, George Harrison of
the New York Fed was in up to his eyeballs in the European crisis. Although he
formally needed approval from the Fed’s Board of Governors in Washington, that
was a mere formality. As part of the crisis management a standstill agreement
on withdrawing international deposits from Germany was put in place.
That standstill agreement kept England from
withdrawing gold from Germany exacerbating a gold outflow that was already in
train. To staunch the gold outflow the Bank of England recommended an austerity
budget which triggered a naval mutiny over pay cuts. It was then only a matter
of time before England left the gold standard and let the pound float.
The German crisis put such a strain on Montague Norman
that he suffered a nervous breakdown and was out of action from mid-August to
late September. However, there was not much he could have done. Hansen
highlights the fact that origin of the European crisis was the after affects of
World War I that left a legacy of inflation along with German reparations
payments and an inter-allied debt to the United States. In June of 1930
President Hoover called for a one-year moratorium on all debt repayments, but
that was scuttled by France. While England would have benefited because it
received less reparations payments than what was owed the United States; for France
it was the reverse.
Thus, reparations and the inter-allied debts hung over
Europe like a dark cloud until the June 1932 Lausanne Conference which
suspended all payments. By then the depression was in full force and Hitler was
well on the way to power.
As someone who read the front page of every New York
Times from August 1929 to March 1933 I have to sympathize with the four bankers
and others who Hansen portrays. They were living day-to-day in a continual
crisis doing the best they can under the circumstances. Hansen takes us into
the weeds, which at times makes it difficult for the reader, it is well worth
it. They did not know how the movie would end and were forced to make sense out
of the situation as they went along. I had the same feeling about the Great
Financial Crisis and the COVID crisis. In case of the latter, the Fed threw out
the Bagehot playbook, by lending on questionable collateral. It worked, but
along with a too aggressive fiscal policy it left a great inflation in its
wake.
