The Inquiring Reader
Reviews, critiques, and thoughts

Lords of Finance - Analysis of Part I

by Liaquat Ahamed

reviewed by Jon Duelfer

Lords of Finance is divided into five parts. Each part is a chronological slice of history, starting at the First World War and ending before WWII.

This analysis reviews Part I – the introduction of the economic, financial, and historical context as well as the aftermath of the First World War. You can find a condensed review of the whole book here.


Boiled down to its essentials, a central bank is a bank that has been granted a monopoly over the issuance of currency. This power gives it the ability to regulate the price of credit – interest rates – and hence to determine how much money flows through the economy.

For much of the 19th and 20th centuries, the gold standard determined the total credit available in an economy. This meant that the amount of available money was bound to the amount of gold extracted from the ground and locked away.

In Lords of Finance, Ahamed shows that as the global economy grew, the total amount of gold was insufficient to support its growth. The constant attempts to fit an economy into a monetary system that was too small for it is what would ultimately lead to the Great Depression. This seems reasonable being that the “totality of gold ever mined in the whole world since the dawn of time was barely enough to fill a modest two-story town house.”

Ahamed introduces his thesis by saying that the “gold standard was incapable of preventing the sort of financial booms and busts that…seem to be deep-rooted in human nature and the inherent to the capitalist system.”

What is not debatable is that there are bubbles and crises “inherent to the capitalist system.” What is debatable, though, is that they are “deep-rooted in human nature.” This is an ideological claim that we have to keep in mind while reading his history.

The Great War Begins

La Belle Époque flourished in the half-century before WWI. People believed that because international trade was so substantial, European countries would not even contemplate war again; the potential economic fallout would be disastrous. Under this newfound belief in liberal capitalism, central banks worked together to send and attract capital from all over the continent.

The United States, on the other hand, could not agree on how to setup a central banking system. Many thought it was un-American and would take away the power of states. The other side – such as farmers – wanted a central, cohesive body to regulate lending. Both sides finally agreed to establish a network of independent, regional banks.

The onset of WWI brought an end to La Belle Époque. European countries turned their economies into machines of war; the price would be mind-boggling. On top of the cost of weapons, vehicles, and troops, as well as the overall effect that war had on the economy, capital had long since fled from Europe to the United States.

Before the war, the U.S. was still relatively small. Receiving capital from Europe – as well as the production and sale of arms and basic necessities to the Allies – made the U.S. into a first-class economic power. European capital, now as gold in their reserves, opened up a massive line of credit that made the U.S. economy surge.

As the U.S. economy grew, Europe buried itself deeper and deeper into debt. The major powers enacted an array of policies to bring themselves out of this cycle.

Britain was able to collect international investment. Before the war, they were the “financial capitol” of the world. Even though their economy was volatile, foreign countries still saw their finances as intact.

France was fortunate enough to have a thrifty middle-class. The government issued government bonds and injected that money into the economy.

Germany was a completely different story; on the losing side of the war, and now buried in debt and reparations, there was no light at the end of the tunnel. Certain that they would default, they took the route of inflation.

The Aftermath

The Great War ended and “11 million men laid dead.” The Allies blamed the Germans. They wanted reparations now that their economies were in shambles and their workforce sparse.

The U.S. argued that reparations payments should be small – no larger than $10 billion – knowing that all of their economies were now tied together. Britain asked for much more. France even asked for $50 billion.

The infamous British economist, John Maynard Keynes, made his way onto the international scene by writing The Economic Consequences of the Peace. In it, he argued that there should be no reparations extracted from Germany, and that war debts should be nullified. He believed Europe would recover much faster this way.

The Allies did not agree with Keynes. Germany was made to pay $2.5 billion in reparations on top of war debts, pensions to veterans and widows, compensation for lost private property under the Treaty of Versailles, insurance for the unemployed, healthcare, and a number of other government programs. The only way they saw to pay for this was to inflate their currency.

In 1914, the mark stood at 4.2 to the dollar, meaning that a mark was worth a little under 24 cents. By the beginning of 1920, after the full effects of the inflationary war finance had worked through the system, there were 65 marks to the dollar – the mark was now worth only 1.5 cents – and the price level stood at nine times its 1914 level.

It turned out that 1920 was only a warning to what would later happen in 1923:

…Germany experienced the single greatest destruction of monetary value in human history. By August 1923, a dollar was worth 620,000 marks and by early November 1923, 630 billion.
     Basic necessities were now priced in the billions – a kilo of butter cost 250 billion; a kilo of bacon 180 billion; a simple ride on a Berlin street car, which had cost 1 mark before the war, was now set at 15 billion. Even though currency notes were available in denominations of up to 100 billion marks, it took whole sheaves to pay for anything. The country was awash with currency notes, carried around in bags, in wheelbarrows, in laundry baskets and hampers, even in baby carriages.

While Germans spent whatever money they had as quickly as possible – unsure of what its value would be only hours later – foreigners encountered ludicrous exchange rates. French, British, American, Swish, and Polish tourists could essentially buy anything they wanted.

They flocked to Berlin to spend vacations, and even bought houses at ridiculously low prices. If their was already a lingering resentment of foreigners since the war, that resentment only grew.

Deflation or Devaluation?

Reparations are often cited as the reason for WWII. Ahamed makes it clear that although reparations certainly were one of the main factors, a primary need for reparations was the enormous amount of war debts outstanding between the United States and the Allies.

The Allies had to pay their debts to the U.S.. To do so, they had to demand reparations from Germany. At the same time, the U.S. was loaning money to Germany. There was, essentially, a never ending cycle of debt and payments.

Because they had already decided that reparations and the payment of war debts were necessary, each country had to choose deflation or devaluation to be able to get out of debt.

Whether to deflate or devalue became the central economic decision for every country after the war. The burden of deflation fell on workers, businesses, and borrowers, that of devaluations on savers. The fate of the world economy would hinge over the next two decades on which path each country took. The United States and Britain took the route of deflation, Germany and France that of devaluation.

From the results of this decision, it doesn’t seem like either was more correct. The U.S. and France bounced back, while Britain and Germany fell behind.

… whereas the U.S. economy, more dynamic and unhampered by a large internal debt, was quickly able to bounce back from the recession, Britain remained stuck. The number of unemployed would not fall below one million for the next twenty years. It soon became apparent that Britain had sustained terrible damage as an economic power during the war. Industries such as cotton, coal, and shipbuilding, in which it had once led the world, had failed to modernize and the traditional markets had been lost to competitors. Labor costs as had risen as unions negotiated shorter working hours.

Here is an example of the liberal capitalist ideology that bleeds through Ahamed’s writing. Offhandedly, he posits that “labor costs,” “unions,” and “shorter working hours” were reasons that Britain’s economy “remained stuck.”

This wildly misses the mark. It was Britain’s choice to pursue deflation and its belief in its pristine finances that led it to remain stuck. To blame labor – in a time that Britain would both raise taxes and cut unemployment benefits in the middle of a crisis – is ludicrous.

That critique aside, the fact of the matter is that almost everybody is struggling to pull their economies out of a recession. They can’t do so without credit.

The concentration of the world’s key precious metal in the United States had left the rest of the world with insufficient reserves to grease the machinery of trade. The world of the international gold standard had become like a poker table at which one player has accumulated all the chips, and the game simply cannot get back into play.

In order to save its economy, Europe would have to question the gold standard. I’ll outline how this occurred, soon, in Part II.