III. THE DETAILS 
Alone among the participants, the United States had a good war. Its casualties were fairly light. War lending vaulted its banks into the top tier of international finance. War production fattened its export earnings. The twin impact of conscription and full-blast operation of its factories brought unemployment to the vanishing point. With European agriculture moribund, farmers in the United States vastly expanded their production—as did farmers in Australia, Argentina, and other commodity producers.
After the short and sharp 1920–1921 recession, real growth took off. For the eight years from 1921 through 1929, the economy clocked in a healthy 5 percent real rate of growth. But that was the least important part of the story. The twenties in America were a glorious decade when a cornucopia of new products and technologies stamped themselves on the brains of Americans, radically changing their outlooks, their lives, and their ambitions. A byproduct of that transformation was that the country became very rich: by war’s end, almost without noticing it, it had nearly quadrupled its prewar gold trove.
The 1929 stock market crash was a loud announcement that the economy had overheated. It did not cause the Depression. The outward aspect of the American economy at the start of 1929 was that of a sleek and smoothly humming machine, but a peek under the hood might have raised some doubts. Economists have been doing lots of poking for nearly a century now, and have identified a number of warning flags.
For instance, Americans had enjoyed a rather remarkable binge in consumer debt, which has been thoroughly dissected by Christina Romer, Frederic S. Mishkin, Martha Olney, and Christopher Brown, among others. Around 1929 households were pulling back sharply on consumer durables, presumably because the market crash had raised their anxieties and weakened household balance sheets.22 More portentous than consumer debt, however, was the very large run-up in home mortgages. The total outstandings were $27.5 billion in 1930, or 30 percent of the 1930s GDP.* The housing market collapsed in the early 1930s; nationwide the loss in value was about a third. Little help came from the federal government until 1935 and the advent of the Home Owners’ Loan Corporation (HOLC), which was after a recovery was already well underway.23
Developments in financial services undoubtedly also played a part in the downturn. Modern scholarship has considerably modified the Friedman and Schwartz hypothesis that 1930s banking failures precipitated the Depression. But work by economists such as Charles Calomiris, Ali Anari, Alexander Field, and Ben Bernanke has shown that suspensions of banks can immobilize reserves and shrink the money supply. Winding up a failed bank in the 1930s took an average of six years. Failed banks also disrupt credit intermediation, as customers acclimate to new lenders and vice versa. The 1928 and 1929 stock market boom also locked up an inordinate amount of cash in deadweight broker transactional accounts.24
Then there is the hoary theory that too much of the national income flowed to the richest, which is certainly true. Workers increased their incomes in the 1920s, but mostly by working more hours, even as output per hour rose sharply. At the same time, the share of pretax income flowing to the top 1 percent was the highest ever recorded, although just a couple of decimal points ahead of that recorded in 2006. The 2000s, of course, also saw a boom in consumer credit, so the average earner could maintain an accustomed level of spending, with notably unhappy results.25
The lists above demonstrate that the economy was vulnerable. But put them all together, and add in the quarter of excess automobile production in 1929, and you still don’t get a Great Depression—a nasty recession undoubtedly, certainly more than a “correction” as in 1924, but not Hoovervilles and men selling apples in the streets.
Of the three European major countries, Great Britain emerged from the war ostensibly in the best shape. It was both a debtor to the United States and a creditor primarily to France and Belgium. British statesmen hoped that the United States would join with them in renouncing reparations payments in return for the forgiveness of all war debts. Quite likely, that would have paved the way for an orderly financing to restore Belgium and France, and, presumably with stringent disarmament conditions, lending to put the German economy on its feet. The deep-seated German sense of grievance over the way the war ended still may not have been completely assuaged, but without reparations to rub into the psychic scabs, the clawing sense of injury may have faded much faster.
Simple and reasonable as that sounds now, there was no chance of it happening. The United States was the only country with the wherewithal to sponsor so generous a solution, and neither the Congress nor the country would have stood for it. Charles Kindleberger’s disappointment that the United States could not act as the “hegemon” as it did after World War II was misplaced. America was still an adolescent nation: powerful and clumsy, unsure and suspicious. A generation later, the role of hegemon felt natural. In 1919 the trousers just didn’t fit.
Nor, sadly, was the former hegemon, Great Britain, able to step into the gap. For all its deep experience in global politics and its great financial acumen, its day as the world power was over. Its halting recovery in trade is indicative: British trading volumes in 1924 were £212 million lower than in 1913, a huge slippage. And it got worse. Taking 1924 as an index base of 100, export volumes in Western Europe had climbed to 134 by 1929; Great Britain’s had crawled back to just 109.26 All of its traditional industries were in a serious state, union pressures were unrelenting, its management class was one of the worst in Europe. The heedless return to sterling at the traditional parity was the final nail in the coffin.
Germany, by contrast, appeared to be almost in blooming health. In the mid-twenties, it had recovered from its great inflation and was abiding by the Dawes plan. In a 1927 review, the great Swedish economist Bertil Ohlin wrote that, after a shaky start, the Dawes regime had stabilized wholesale prices, improved the country’s trade performance, and was making real headway against unemployment. But it was a mirage; Germany was on the road to collapse and would bring the rest of Europe and the world down with it.27
Great events are usually overdetermined. The critical reality of postwar Germany was its utterly toxic politics. The ambiguous surrender, after German troops had been hailed as “conquerors” as they marched into Berlin, called forth recriminations and conspiracy theories of all stripes. The November 1918 “half revolution” initiated some ten months of internecine violence before an unstable socialist coalition established a shaky government at Weimar. The violence abated but did not end. The assassination of two respected finance ministers—Matthias Erzberger and Walter Rathenau—conveys a sense of the disorder.
Germany had no money to speak of at the war’s end, but they still had credit—lending markets were in a bullish mood and decided that the motley assemblage at Weimar would exercise the same fiscal rectitude as its Prussian forebears. Loans came flooding in, which governments squandered on sweeping social legislation and subsidies, while omitting the provision of any tax revenues. The deficits were funded by untethered issuance of paper Reichsmarks, and within the blink of an eye in economic time, the German currency floated from the solid clay of earth toward the Kuiper Belt.
After the Stresemann-Schacht 1924 currency reform broke inflation and revitalized the internal German economy, the Reichsbank was recapitalized with proceeds from the Dawes loans, allowing a couple of years of recovery and relative stability. It was at that point that the source of reparations payments was supposed to shift from external loans to proceeds from German taxes and bond issues, secured by railroads and heavy industry, which were nearly debt-free by virtue of the hyperinflation.
In principle, Germany could have paid the reparations. The final version of the Dawes plan brought the total liability very close to, indeed probably less than, the total that Keynes had pronounced as reasonable in his Economic Consequences. But the politics of the day made such speculations irrelevant. Just as there was no possibility of the United States acting as a benevolent global hegemon in 1919, there was no possibility of Germans voluntarily paying reparations with their own money.
The casualness of German public finance was matched by the deplorable condition of Germany’s major banks, particularly in the aristocracy of German banking, the six Berlin Grossenbanken, or “the great Berlin banks.” They had emerged from the inflation with only a fifth of their prewar capital, but nonetheless expanded rapidly and increased their risks to boost their earnings. Scarily, 42 percent of their deposits were for the accounts of foreigners. The Danatbank that failed in 1931 was only the worst of the lot.
Bad as the state of the Berlin banks was, German politics was even worse. Unable to pass a budget, the Reichstag president, the eighty-four-year-old Paul von Hindenburg, appointed a new chancellor, Heinrich Brüning, a leading figure in the Prussian Catholic Centre Party, to get public spending under control. Brüning produced a draconian budget, which was passed only after von Hindenburg called a snap election, the fateful poll in 1930 that made the Nazis the second most powerful voting bloc in the Reichstag.
Brüning, however, cut an impressive figure. A tour of the world financial centers drew raves from the financial press and generated healthy price appreciation for the Young plan bonds. Even the French, with a new government under Pierre Laval, with Aristide Briand as foreign minister, both of them interested in a démarche to Germany, declared an interest in lending to Germany.
At that point politics intervened. The investment bankers syndicating the loans had a territorial spat that slowed the process. Then Brüning, at his patron von Hindenburg’s insistence, included a new pocket battleship and other armaments in his supposedly bare bones budget, deeply embarrassing Laval and Briand. Von Hindenburg also announced that he was exploring a customs union with Austria, which looked like, and was quite likely intended to be, a first step toward a merger of the two countries, which was forbidden by Versailles.
And then Brüning’s budget fell apart. Although it had appeared reasonable when it was announced, German incomes were falling far more rapidly than expected, and mandatory unemployment and other benefits were soaring. By that time Brüning’s string had pretty well played out.
Markets then learned that the Reichsbank’s bailouts of Danatbank and other bleeding great banks had brought it close to breaching its legal gold cover. The president, Hans Luther, shut the gold window. Fire sirens ululated through trading rooms. Göring and the Nazis were in full cry. Generals prepared troops for civil unrest. There is considerable evidence that the panicked flight of money was led predominately by Germans, rather than foreigners. Stories abounded of wealthy Germans toting suitcases of money to the Netherlands and Switzerland. Americans reportedly took heavy losses.
The Reichsbank’s repudiation naturally transferred the pressure to Great Britain, which had $300 million stuck in the German financial tundra. After burning up its own reserves and several very large external loans through August and early September, Ernest Harvey, Montagu Norman’s deputy at the Bank of England, made the decision to stop making gold payments as of September 21, 1931.
The French were the last still standing. But the field they had won was stripped bare. They managed to keep most of the gold bloc countries together for a few more years. But they were finding it expensive, since the deflation they had been forcing on the rest of Europe was destroying the French pricing advantage from their undervalued franc.
The deflationary winds blowing from Europe had turned into a hurricane. The collapse in agricultural prices, the prostration of trade, the Fisherian debt deflation that set bankers everywhere scurrying for cover, the precipitate collapse in manufacturing output, it all swept over America—the country that had the farthest to fall, and indeed, fell the farthest. Friedman and Schwartz speculated that the creation of $1 billion of new money in 1930, when the economy was still teetering on the brink of collapse, could have arrested the downturn. They’re probably right, but virtually all the contemporary experts knew that would just make things worse. It took a political lightweight, with an appetite for experimentation, to prove that the experts were wrong—at least this time—and even Franklin Roosevelt lost his nerve in 1937.28
Dreadful as the Depression was, however, it paled against the fact that Germany had withdrawn behind its mental fortresses and was gearing up for what Churchill called the Second Part of Europe’s new Thirty Years’ War.