Sovereign Soldiers. Grant Madsen

German officials thought they saw an opportunity in their growing dependence on American finance. “One must simply have enough debts,” explained Gustav Stresemann, the foreign minister. Indeed, “One must have so many debts that, if the debtor collapses, the creditor sees his own existence jeopardized.” In his version of too-big-to-fail, Stresemann imagined that, “These economic matters build bridges of political understanding and of future political support.”⁴ He hoped that the bridge would reach from Berlin to New York and on to Washington so that eventually the American government would feel obligated to protect Germany’s economic health in order to protect itself as creditor.

      While Germany ran up its debt, many other countries worked to get back onto the gold standard. For much of the nineteenth century, the standard had facilitated global trade and economic growth. In war most countries had suspended it to have a freer hand in financing production. While a great deal can be (and has been) said about the gold standard, two features are worth focusing on here. First, it embodied particularly well the “invisible hand” of market relationships and, in this sense, had a kind of legitimacy for standing outside of politics. Just about everyone could understand how it worked since it generally followed principles of personal finance. If a country bought more than it sold on international markets, it experienced about the same consequences as individuals who bought more than they earned. For individuals, the consequence was frugal living; for nations, frugality meant less total money in circulation (what economists label a “forced” deflation) because money (gold) now belonged to another nation. In practical terms, when a nation ran out of gold, it usually suffered a recession and rising unemployment. To be “on gold” meant governments had no monetary policy as such; they followed “the market,” discarding “independent national [economic] objectives of their own.”⁵

      Second, the gold standard signaled an acceptance of international norms. After World War I, norms appealed to many policymakers around the globe.⁶ More specifically, gold signaled an effort to make good on Woodrow Wilson’s vision of a global marketplace. Gold acted as a check on “independent national objectives,” which in the early twentieth century often expressed themselves in right-wing nationalism and militarism. Gold, in this sense, stood for peace rather than nationalist conflict.⁷

      Unfortunately, returning to gold after the First World War created as many problems as it solved—particularly for the British. The world economy had changed during the war, and the pound should have devalued coming out of it. Yet British officials insisted on maintaining the pound’s prewar value. In reality, it forced the British economy into deflation and chronic recession. Depreciation could have helped revive the economy, only to make British war debt relatively larger. In the end, British officials stuck to the higher value of the pound despite the economic hardship.⁸

      The British economy would have benefited from American investment to make its products more competitive. Indeed, nearly all of Europe needed American investment for the same reason. German municipalities managed to get a larger share of American loans because they promised (unrealistically) greater returns. Ultimately, though, European recovery often followed American investment, and this flow continued at least piecemeal until 1928, when no level of return competed with what the New York Stock Exchange offered.

      Figure 3. Dow Jones Industrial Average, 1925–1930. Source: Federal Reserve Bank of St Louis, FRED Economic Data, Dow Jones Industrial Stock Price Index for United States (M1109BUSM293NNBR).

      The Dow Jones rose impressively between 1925 and 1928, going up 64 percent—a large increase, but not out of step with the growing productivity of the American economy. It then spiraled an additional 82 percent in just one year, and this increase had little to do with rising productivity. The promise of such great returns caused money to flow into Wall Street from around the globe, adding fuel to the speculative fire and draining investment from everyone else. Thus, as the American market took off, the British, German—even the Japanese economy—slipped into recession.⁹

      Surveying Wall Street at the end of 1928, president-elect Herbert Hoover grew nervous. He and the governors of the Federal Reserve decided to burst “the bubble.” The central bank raised interest rates from 3.5 percent at the end of 1927 to a high of 6.0 percent by the summer of 1929. The rate hike had the intended effect, and industrial output began to decline. Yet the stock market ignored the data and continued to go up until, famously, in October, it lost spectacularly.

      Figure 4. U.S. bank loans, 1925–1941 (billions of U.S. dollars). Source: Federal Reserve System, Banking and Monetary Statistics, 1914–1941 (Washington, DC, 1941).

      European central bankers, and particularly the British and Germans, met the market crash with enthusiasm. In theory, once Wall Street stopped siphoning gold from around the world, investment would return to them. Yet their expectations were frustrated because at that moment the global financial system lay under tremendous pressure. Banks around the world had begun to fail and had stopped lending altogether. Worse, as credit collapsed, the economy in many countries slipped from recession to depression.¹⁰

      By 1930, the moment of truth came for the German economy. In October the former German financial official Hjalmar Schacht made a trip to the United States. He pleaded with the American people to accept a revision of reparations and forgive war debts. “Never before,” asserted Schacht, had “a conquering force first taken from the vanquished all that they had in colonies … and then demanded the conquered people … to pay still more.”¹¹ If America took the lead in debt and reparations forgiveness, Woodrow Wilson’s ideal might get one last chance to succeed. But the American press wanted to talk instead about the upstart Nazi Party. They wanted a sense of who Adolf Hitler was and how he had become so popular so quickly. Frustrated, Schacht explained, “You must not think that if you treat a people for ten years as the German people have been treated they will continue to smile.… If the German people are going to starve, there are going to be many more Hitlers.”¹²

      Without American loans, German authorities announced they could not make the next installment of reparations. Without reparations, the British and French could not repay their debts to America. Seeing that the global system lay on the brink of collapse, Herbert Hoover declared a oneyear moratorium on reparations and war debts, finally acknowledging what European authorities had argued since 1919. Hoover hoped that with time the Germans, British, and the rest of Europe might turn their economies around. None did.

      Unfortunately, reparations represented only part of the problem. German municipalities also started defaulting on their loans, causing additional shocks to the global banking system. To slow the financial crisis, Berlin applied exchange controls to prevent gold from leaving its banks, as did nearly all Central European countries (Czechoslovakia, Bulgaria, Romania, and Yugoslavia).¹³ By the end of summer, 1931, the Bank of London was near panic as gold drained from it as well. Seeing no other alternative, on September 20, the British left the gold standard. “The struggle to bring the British pound back to par after the World War,” wrote the New York Times, “will rank among the epic contests of world finance. That struggle has failed.”¹⁴ The value of the pound finally dropped, losing 20 percent against the dollar. Almost immediately Sweden, Norway, and Egypt followed England off of gold. Many countries began to negotiate exchange rates bilaterally. In response, the United States suffered a new wave of bank failures corresponding to the financial crises in Europe, killing what had looked like a modest recovery in the first part of 1931.

      The combination of Hoover’s moratorium and Britian’s move off of gold seemed to indicate the time had finally arrived to rethink the whole issue of reparations and war debt. In the summer of 1932, in Lausanne, Switzerland, leaders from the principal European countries gathered and, in a “gentlemen’s agreement,” decided that they would set aside German reparations once the British and French had “satisfied” their obligations to the United States. “We are still ready to cancel all debts due us,” explained Neville Chamberlain, then chancellor of the exchequer, “If the United States should decide to cancel all debts due