JEFFREY BROWN: Beneath the veneer of boomtown prosperity, cracks began to appear. Well, that sounds familiar to us today, but it’s actually a description of a point in the 1920s, just before the Great Depression hit, when four central bankers from the U.S., England, Germany, and France would make some big decisions that reverberated with huge consequences.
The story of those four men and what they wrought is the subject of a new book, “Lords of Finance: The Bankers Who Broke the World.” Its author, Liaquat Ahamed, has worked on Wall Street and at the World Bank and now as an investment fund manager.
Welcome to you.
LIAQUAT AHAMED, author, “Lords of Finance”: Thank you, Jeff.
JEFFREY BROWN: It’s hard not to jump right into parallels, but take us to that moment in time. It was, like ours, a time of upheaval and change.
LIAQUAT AHAMED: Yes, very much so. The world — 1929 was only 10 years after the First World War ended. The First World War left an enormous overhang of debts. And during the ’20s, the four central bankers, who are in my book, were trying to rebuild the world, and they were trying to turn the clock back to 1914. And for…
JEFFREY BROWN: Before the war changed everything.
LIAQUAT AHAMED: Everything, yes. And for a while, they looked as if they succeeded, and they created that veneer of boomtown prosperity. It turned out they were wrong, and things began to fall apart in 1929.
Focus on decision makers
JEFFREY BROWN: Why was it -- I mean, it's an interesting to way to look at history through four central bankers. We don't usually think of them as perhaps the most compelling parts or figures in history. But why was that a good way in?
LIAQUAT AHAMED: Because I wanted to try to turn the spotlight on economic decision-makers rather than on the economy. We read economic history, and there's a sort of certain sense of inevitability about what happens.
And what I want to do was show that there were -- that economic developments were the result of key decisions made by key officials and that, at every step of the way, they could have taken different decisions.
JEFFREY BROWN: And key officials who were living in a world that was, in some ways, very different from ours. They knew each another, but they couldn't even talk on the telephone, for example, right?
LIAQUAT AHAMED: No, they actually became -- three of them became quite good friends. They would vacation together. The American central banker, Benjamin Strong, would go to Europe every year and spend three months there. And he would go around the main cities of Europe visiting central bankers, and then he would take a month vacation, often in the south of France or Beirut, with one of the other central bankers.
Significance of gold standard
JEFFREY BROWN: Now, they were still, though, renowned in their time, very famous. You say they were referred to as the most exclusive club in the world; that has a ring of familiarity, doesn't it? The subtitle, though, is "The Bankers who Broke the World," so you started to tell us that something went wrong. What did they do wrong?
LIAQUAT AHAMED: Two things. One is they put the world back on to the gold standard after the First World War, and it was like putting the world into a monetary straight jacket.
JEFFREY BROWN: Explain that.
LIAQUAT AHAMED: The gold standard essentially was a system by which central banks determined the amount of credit they provided to the economy based on the amount of gold in their vaults. The problem was that, during the First World War, from 1914 to 1919, gold production collapsed, there wasn't enough gold in the world when they put it back, and as a consequence credit was always too tight. So that was the first problem.
The second problem was the rate at which some of the currencies had gone on to the gold standard. And in particular, Britain had tried to turn the clock back to 1914 and regain its position as the premier financial center of the world. And that proved to be a very big mistake, because they had almost bankrupted themselves during the First World War.
Similarities between eras 'eerie'
JEFFREY BROWN: Now, as you say, in these years, they were taking all kinds of actions, but they were clearly flying blind, to some degree, and while perhaps feeling like they were running history, they were being swept along, as it turned out. Now, that has parallels to our own time. Do we have our own lords of finance today?
LIAQUAT AHAMED: Yes, look, the parallels between now and then certainly in the lead-up to this current crisis are eerie. In both cases, we had a bubble. In that case, it was in the stock market; in this case, it was in the real estate market.
Both bubbles were caused by an error in Fed policy. In the '20s, the Fed eased to try to support the pound. In this case, the Fed over-eased in the early part of the decade. Both bubbles eventually burst, as they always do, and both bubbles led to a banking crisis. I think, after that, the parallels differ.
JEFFREY BROWN: Well, are there -- of course, what people want to know is, are there lessons to be learned from that time? Do you see anyone having learned them?
LIAQUAT AHAMED: Yes. We've learnt those lessons; we may have other lessons that we have yet to learn.
When the bubble burst, during the Great Depression, they made three errors. They allowed the banking system to collapse. They tried to keep their currencies on the gold standard, which forced them to raise interest rates in the middle of the depression. And they were obsessed by keeping the budget deficit under control.
We're making none of those mistakes. So the wonderful thing about the Great Depression, from our point of view, is we know what not to do. That doesn't Â tell us quite what to do.
Banking system has grown
JEFFREY BROWN: Right, because, in your role as a historian, you see people being swept along. Do you see the same phenomenon now? I mean, every day on this show, we're reporting on new things that central bankers and governments are trying.
LIAQUAT AHAMED: Well, here's what keeps me up at night. In the Great Depression, the banking system in this country was actually relatively simple and it was not very large. The total size of the banking system was about 50 percent of GNP. So even though they let it go under, it was actually controllable.
The banking system and the sort of ancillary shadow banking system that we have now in this country accounts for 150 percent of GNP. In Britain, it accounts for 450 percent of GNP. I mean, the extreme case is Iceland, where it accounted for 900 percent of GNP.
So I worry that we've created a sort of financial Frankenstein that we're unable to control.
JEFFREY BROWN: And we know how your book ends, but we don't know how the current story ends.
LIAQUAT AHAMED: No, we don't. Nor do I.
JEFFREY BROWN: All right. The book is "The Lords of Finance: The Bankers Who Broke the World." Liaquat Ahamed, thank you very much.
LIAQUAT AHAMED: Thank you, Jeff.