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The University of Texas at Austin

Lyndon B. Johnson School of Public Affairs




Book Review

Prelude to Disaster



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Please excuse the late intervention. I stayed up last night to finish Lords of Finance and should say first that I recommend it.

This is not a polemical book and it is also not primarily a work of economics, though there is a huge amount of economic history in it. It is first of all the social history of a small, important and largely forgotten group: the central bankers of the early 20th century, in the four countries whose finances, empires and ambitions dominated the globe. No question that the cover image is well-chosen.

At this time the central bank was just beginning to be merged into the nation-state. So one thing that stands out is the extent to which the central banks retained their private character, structures of governance and class allegiances, except in Germany where the war had changed everything. This is not to say that the lords of finance were dishonorable or venal or dumb. It rather points to the limitations of government by people raised in very small clubs.

Ahamed portrays very well the quirky insularity of the Bank of England especially, through the endearing, quaint and utterly unaccountable figure of Montagu Norman. One consequence was that personal relationships mattered hugely: Norman and Strong, Norman and Schacht, Norman against Moreau. Loans in the hundreds of millions turned on who liked and trusted whom. And governance of this kind was bound to hit limits as democracy encroached: Norman was witty, charming and erudite in private but unsuited to explaining bank policy to the wider world.
In the background here - but out in this wider world -- are the political figures we know, including Churchill, Hoover and Roosevelt, not to mention Hitler. So part of the book is an account of how the state began the process of taking over economic policy from the central banks - the rise of fiscal policy and the decline of credit policy as political history. The end of the gold standard should be seen in this light: it liberated national governments from fiscal control, and shifted power and influence away from he who controlled the reserves and Bank Rate. The Lords of Finance were part of an ancien regime, a world in decline.

They were also in intellectual decline and it is striking here how one figure, an irritant and gadfly, looms over the comfortable and limited horizons of these people. That is of course John Maynard Keynes, who plays almost as large a role here as the principals. Keynes is of course fascinating, but known to most of us (if at all) mainly through his writings for economists (the General Theory) and the public (Essays in Persuasion). Ahamed places him in another context, and it is very interesting to see him in operation, not so much as a contestant in the academic wars but as a bridge to modernity in the governance of finance.

The tragedy, for us, is that the world today has reverted toward the model of the 1920s. In the US, we long ago established (through the Humphrey-Hawkins process) a model for professional and political accountability by the Central Bank. The first Fed Chairman to be subjected to the process, Arthur Burns, hated it: Burns was (like Norman) inept and evasive in public; he didn't think the Central Bank should be subjected to the indignity of actually answering questions. ( I know about this, because it was my job to write the questions.)

Paul Volcker was much more professional; despite his differences with Congress over policy he brought the Federal Reserve much more closely into an appropriate legal relationship with public power. But then, with Alan Greenspan, the capacity for oversight faded, because Congress could not cope with the man's talent for obscure expression -- and largely chose not to try.

In Greenspan's time the Fed's apparent power rose, because the economy recentered itself around bank credit and a global dollar standard, while doctrines of small government pushed fiscal policy back into the background. At the same time in Europe a Central Bank was established on the ancien-regime model, independent, above governments and autocratic, led by deeply limited men from the continental elites, while (under a Labour Government!) the Bank of England was restored to independence from the Treasury. Meanwhile in the intellectual arena the followers, admirers and would-be successors to Keynes were pushed firmly to the sidelines or off the stage.

All of this was a prelude to disaster.

The situation today resembles the early 1930s in one other important respect: the incredible complexity of international financial relations. The interwar world crumbled because it could not cope with the renegotiation of German reparations, a merry-go-round that went from American creditors to German cities and towns, to the German state, to the French and British, and back to the Americans. Something very similar, but infinitely more complex, is happening today in the rapidly unraveling world of credit default swaps and the carry trade from the United States, through the UK, Eurozone and Switzerland, and onward to Central and Eastern Europe, and back to the US via the currency swaps through which we are presently keeping the entire, precarious European financial system afloat. (Iceland was just the canary in the coal mine on this.)

Where it will end, is anyone's guess. But the potential for a disaster that cannot be handled by quirky, limited people chosen from insular clubs, and given vast and unaccountable power, is clearly with us again.

Copyright 2009 TPMCafe

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