Tag: episode-1141


April 3, 2015

This week on WEALTHTRACK we discuss the lessons learned and ignored from the powerful central bankers of a century ago. Financial Thought Leader Liaquat Ahamed, the Pulitzer Prize winning author of Lords of Financediscusses the differences and similarities between central bank policies today and those leading up to the Great Depression.

Liaquat Ahamed Author Lords of Finance: The Bankers Who Broke the World

CONSUELO MACK: This week on WEALTHTRACK, financial thought leader Liaquat Ahamed won a Pulitzer Prize for his The Lords of Finance: The Bankers Who Broke the World portrayal of the four central bankers who shaped the global financial system after World War I and leading up to the Great Depression. He shares the lessons learned and mistakes being repeated by central bankers today. Next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack.

Every once in a while we take a break from analyzing current events and news and try to get a different perspective and a greater understanding of what is affecting our financial lives. That’s what we are doing this week. Ever since we recommended the Pulitzer Prize winning book, The Lords of Finance: The Bankers Who Broke the World for our WEALTHTRACK Bookshelf several years ago, I have been meaning to get in touch with its author Liaquat Ahamed to pick his brain about the four powerful central bankers he profiled from the early twentieth century who were basically in charge of the world’s financial architecture coming out of World War I and going into the Great Depression.

They represented the financial centers, largely private of the four economic powerhouses of the time.

There was Montagu Norman of the Bank of England, Emile Moreau of the Banque de France, Hjalmar Schacht of the Reichsbank and Benjamin Strong of the Federal Reserve Bank of New York. How powerful were they? How did we go from the roaring twenties to the desperate thirties? Are their lessons to be learned from their experiences and have we absorbed any?

Liaquat Ahamed came to the topic from his own experience in the investment business, including during some financial crises. From 2001-2004 he was Chief Executive Officer of Fischer Francis Trees & Watts, a fixed income investment management firm and subsidiary of BNP Paribas. Before that he was the firm’s Chief Investment Officer. He was also the Head of the Investment Division of the World Bank.

I started the interview by asking Ahamed what led him to write a history of four central bankers from another era.

LIAQUAT AHAMED: I was in the investment management business and in the late ‘90s, lost a ton of money during the Asian crisis. So that was ’97. And I thought, well, I’d better learn about financial crises because it looked as if we were getting more and more of them. We’d had ’82, ’87, ’90, ’94, Mexico. And started reading up about past financial crises, and obviously the mother of them all was the Great Depression.


LIAQUAT AHAMED: And stumbled across this story of a meeting of four central bankers on Long Island, at what is now the Westbury Country Club, I think. And said, “God, wouldn’t that make a fascinating story about the background to that?” At that time, Time Magazine ran a cover story, a very famous one, which was “The Committee to Save the World,” which had Alan Greenspan, Bob Rubin, Larry Summers; and I thought, “Great, I’ll write a book about these four guys who were the committee to save the world in the 1920s, but actually, broke the world.” So that was how the idea came to me.

CONSUELO MACK: This was before our most recent financial crisis.

LIAQUAT AHAMED: Oh, yes. This was in 2000, 2001.

CONSUELO MACK: So you had no inkling whatsoever that what would transpire after that, which is so interesting.

LIAQUAT AHAMED: Well, no. But I did think that financial crises were here to stay and that we should understand them better.

CONSUELO MACK: And they are more frequent, I have heard. Is that the case?

LIAQUAT AHAMED: Oh, yes. We used to get them every ten years in the 19th Century. And that continued right through till the Great Depression. The reforms that were put in place, both in banking and the limits on free capital movements that came out of the Great Depression actually stopped financial crises for 30 years. So from 1940 until the mid-1970s we actually had relatively few financial crises. And then as Bretton Woods fell apart, as capital started flowing freely around the world, we started getting them.


LIAQUAT AHAMED: It’s sort of a price you pay for free capital flows.

CONSUELO MACK: The title of the book, “Lords of Finance, the Bankers Who Broke the World,” how powerful were they?

LIAQUAT AHAMED: Well, central bankers were very powerful in some sense in those days because all central banks were private institutions. I mean, even the reserve banks at the Fed were private institutions. The Bank of England had private shareholders. So did the Banc de France. And central bankers determined their own objectives. So not only did they have operational independence, they decided what was most important. And what they decided was most important was stability in the value of the currency. Every other objective was subordinated to that. So the Bank of England’s goal, and sole goal, was to maintain the Pound Sterling.

CONSUELO MACK: The Pound. Right.

LIAQUAT AHAMED: And it was willing to tolerate all levels of unemployment, in order to achieve that. So that is incredibly powerful because now central bankers have operational independence, but they don’t decide their own objectives. Those are decided by politicians. So to some degree, central bankers were much more powerful in those days because they had no oversight by politicians.

CONSUELO MACK: And yet, when you think of the Fed, the Federal Reserve Bank, it is in fact, it’s independent. They are appointed by the president, but they’re self-governing to a certain extent. And they have very definite goals. I mean, in the case of the Fed, two goals.

LIAQUAT AHAMED: But those goals are decided by Congress.


LIAQUAT AHAMED: They don’t decide those goals, and that’s the key thing. And they have to go and testify to Congress about what they are trying to do, and whether they’ve achieved their objectives. Whereas Montagu Norman, who is the premier central banker of his generation, head of the Bank of England…


LIAQUAT AHAMED: … never testified to Parliament …

CONSUELO MACK: Parliament or …

LIAQUAT AHAMED: … and once was called to testify in the ‘30s after the Great Depression. And he’s sitting in front of all of these Parliamentarians and they say “Governor Norman, what were your reasons for doing these things?” And at first he didn’t answer and just tapped his nose three times, and then he said, “I don’t have reasons, I have instincts.”

CONSUELO MACK: That is a frightening thought…to hear that. Of course, after the financial crisis we do know in many cases that all of our government officials and the Fed officials were relying on their instincts to a certain point too, because they were kind of flying by the seat of their pants.


CONSUELO MACK: But to hear that is definitely sobering. So what did you mean by that “they broke the world”?

LIAQUAT AHAMED: I think the central thing that happened in the ‘20s was the decision to go back to the Gold Standard after the First World War. The First World War was an incredibly expensive venture.


LIAQUAT AHAMED: European economy spent 50 percent of their GDP per year for four years fighting that war. They came out saddled with enormous amounts of debt.

CONSUELO MACK: And all of their young men, generations lost and … right.

LIAQUAT AHAMED: Lost. Exactly. And they, on top of that, they decided to try to turn the clock back and return back to the Gold Standard at the exchange rates that prevailed in 1914 when they went to war. And that was a terrible mistake. And that was the single worst mistake made by these central bankers.

CONSUELO MACK: Again, because their major motivation was to stabilize their respective currencies, so that stayed as their objective, and that’s how they knew to do it. How to do it, right?

LIAQUAT AHAMED: Yes. Exactly. And they could not understand a world … they just did not believe that you could have a world where central bankers had discretion. So ironically they thought that the best financial system was to tie their currency to gold in a completely rigid way.

CONSUELO MACK: What are the parallels between what they faced in the early 1900s and to what we faced going in to our last financial crisis of … 2008, 200- …?

LIAQUAT AHAMED: So I think the way I would divide it up is, the parallels in the lead up, and then the parallels in the crisis.

CONSUELO MACK: Yes, while they’re in it. Uh-huh.

LIAQUAT AHAMED: So the parallels in the lead up were, in both cases, we had a malfunctioning global financial system. One case had occurred because Europe was saddled with debts after the First World War. In the other case, it arose because of massive accumulations of reserves by the Asian countries. In both cases this malfunctioning international financial system led to the Fed being forced to take decisions that led to excessively low interest rates.

CONSUELO MACK: Right. In this case it was under Alan Greenspan’s tenure was the Fed Chairman and …

LIAQUAT AHAMED: Yes, well, and it was, you know, Alan Greenspan will say it wasn’t my fault. It was that the Asian countries were buying all the government bonds and driving down long term interest rates. In the ‘20s it was that the Fed deliberately kept low interest rates in order to support Europe, and in particular, to support the pound. In both cases, those low interest rates provoked a bubble. In the ‘20s it was in the stock market.

CONSUELO MACK: Here it was in …

LIAQUAT AHAMED: And … in real estate.

CONSUELO MACK: … housing. Uh-huh.

LIAQUAT AHAMED: And in both cases, the bubble burst, as they always do. And in both cases the collapsing bubble didn’t actually cause, but was associated with a banking crisis. And you in effect ended up with two separate crises, a U.S. banking crisis and a run on the U.S. banking system. Then it was on banks. This time it was on the shadow banking system. And you got a separate crisis in Europe which was a combination of a banking and sovereign debt problem. So in the late ‘20s and early ‘30s, we got a European banking problem which was also associated with countries having borrowed too much and defaulting. This time around we had exactly the same problem. So those were the parallels.

CONSUELO MACK: Had you been advising Alan Greenspan at the time, what would you have … and what should he have done differently?

LIAQUAT AHAMED: You know, that’s the central dilemma, because, even in the ‘20s they debated whether they should use monetary policy to control the stock market. Because the stock market was on a tear. And the debate was, is monetary can’t … raising interest rates, is that too blunt an instrument to control a bubble? Because just raising interest rates by half a percent or one percent is not enough when you’ve got a bubble on your hands. On the other hand, you raise interest rates by two, three percent, and you drive the economy into the ditch. And so monetary policy is actually probably exactly the wrong instrument to control bubbles. What you need is some other vehicle. So in the ‘20s they talked about margin requirements. The problem was, they tried to restrict bank lending against stocks, and what happened, whatever happens with regulation, people started bypassing it, and you got massive lending into the stock market, not by banks, but by non-banks.

CONSUELO MACK: Right. Their shadow banking system. Right, right.

LIAQUAT AHAMED: Yes, exactly. So it’s incredibly hard. So my sympathies go out to the central bankers in the 2000s because trying to get this complicated machine under control, when there’s a bubble, is very difficult.

CONSUELO MACK: During the financial crisis itself, what were the lessons learned, and how did we do?

LIAQUAT AHAMED: Well, I think the experience in the ‘20s was that they were too slow …


LIAQUAT AHAMED: … to ease monetary policy. And this is something that people find very difficult to understand. Why was the Fed, which was created to be the lender of last resort … why was it so bad in supporting the U.S. banking system? So the lesson that they learned this time was, one, you, under no circumstances, do you allow your banking system to collapse.

CONSUELO MACK: To fail. Uh-huh.

LIAQUAT AHAMED: And in the’20s they had good reasons. They said, well, the Fed can only take, by its charter, can only take certain types of collateral. The Fed, by its own charter, can only lend to Federal Reserve Banks that were part of the Federal Reserve System. Only 50 percent of the banks in the country were part of the Federal Reserve System which meant half the banks in the country had no lender of last resort. So the Fed in the ‘20s and the ‘30s became a prison of its own rules.

CONSUELO MACK: And they didn’t have the FDIC. They didn’t have deposit insurance, or a lot of things that that Fed didn’t have.

LIAQUAT AHAMED: Whereas this time, the Fed almost broke its own rules. Here, they went to the absolute limit, and Paul Volcker said it very well. He almost said they went over the limit …


LIAQUAT AHAMED: … of the sort of spirit of the law, in what they did, and thank God they did, because they acted as lender of last resort. So that’s the single most important lesson.

CONSUELO MACK: So you would give accolades, then. You would laud how the Fed …

LIAQUAT AHAMED: They should build statues to those guys.


LIAQUAT AHAMED: So that situation in Europe is not quite so happy because the lesson in the 1930s was that when countries get themselves excessively into debt, and that they cannot borrow, the answer is debt restructuring.

CONSUELO MACK: Austerity, painful process. Right?

LIAQUAT AHAMED: Well, there’s some element of austerity but you don’t want excessive austerity. And part of the problem of when a country has borrowed too much, two people are at fault. The borrower and the lender.


LIAQUAT AHAMED: And the lender needs to take a hit. In the ‘30s, Germany was the culprit of having borrowed too much. It had borrowed vast amounts in the U.S. to pay reparations. It still owed reparations to Britain and France.

CONSUELO MACK: After World War I.

LIAQUAT AHAMED: Yes. And the French refused to allow Germany any leeway in reducing those debts. So Germany had no alternative but to tighten austerity. The German depression in ’31, ’32, ’33 was even worse than the U.S. depression. So this time round we should have restructured Greek debt earlier. Instead, we insisted that they hunker down and pay off those debts, and they’ve ended up in a situation where they’ve still got too much debt and the problem is still consuming us.

CONSUELO MACK: Therefore, your advice to Mario Draghi as an ECB would be what?

LIAQUAT AHAMED: Yeah. Mario Draghi is doing what he can.

CONSUELO MACK: Now. Finally.



LIAQUAT AHAMED: But my advice to the Germans is that Greece has debt of close to 200 percent of GDP. No one pays off debt that’s 200 percent of GDP, so just bite the bullet and reduce those debts.

CONSUELO MACK: Through just restructuring, not forgiveness necessarily, but kind of the equivalent of a certain extent.

LIAQUAT AHAMED: Well, ultimately it’s always forgiveness.

CONSUELO MACK: Right, right.

LIAQUAT AHAMED: You don’t have to forgive all of it, but you’ve got to forgive a big chunk of it.

CONSUELO MACK: Seven years from the financial crisis, from the beginning of the financial crisis now, and we’ve had record low interest rates. We’ve had unprecedented monetary policies of bond buying, and it’s still going on in the rest of the world. What do you think the outcome’s going to be?

LIAQUAT AHAMED: Well, I think we’re clearly getting a recovery here.

CONSUELO MACK: Yes, here we are.

LIAQUAT AHAMED: Europe is still, because they were very slow to deal with the debt problem and the competitiveness problem in southern Europe is, let’s say, five years behind us. So Europe will probably have stagnation for the next few years.


LIAQUAT AHAMED: So we’re getting out of the recession. What are the long run consequences? I suspect that we’re going to have a long period of deleveraging.

CONSUELO MACK: Among governments.

LIAQUAT AHAMED: No, and also in the private sector.

CONSUELO MACK: All right. Because corporations actually in the U.S. have deleveraged.

LIAQUAT AHAMED: Have de-levered. And households are sort of slow to … there’s some uptick in debt but if you compare it to seven years ago, household debt has gone down.


LIAQUAT AHAMED: So we’ll get a period where people will use less debt. Now, during the 1930s we got this massive recovery. Debt did not increase. And bank credit actually went down. So you’ll say, well, how did people finance it? With equity. The lesson to learn from the financial crisis is that you need to rely more and more on equity to finance things, and less and less on debt.

CONSUELO MACK: Not on a consumer point of view, right? Not from individuals, but obviously from … right …

LIAQUAT AHAMED: From a global point of view …

CONSUELO MACK: From a global point of view.

LIAQUAT AHAMED: … you have to borrow less because when you borrow too much you get yourself into terrible trouble.

CONSUELO MACK: Right. Is there any way, again, looking back on the lessons that you’ve learned as an historian, is there a way to prevent a severe financial dislocation, or a financial crisis, period?

LIAQUAT AHAMED: You know, I’m skeptical. It’ss hard enough just to conduct monetary policy in a responsible way, and take away the punch bowl when the party gets going and raise interest rates. But it’s really difficult when a bubble is forming for a central banker to come in and say, all this wealth that you think you’re making is all illusory, and they’ll get accused of trying to undermine American prosperity. So I’m very skeptical that central bankers will have the sort of political cover to seriously cope with boom times to prevent the busts that follow. Now, financial crises don’t occur every year. And big financial crises, luckily, seem to be a once in a generational things. And Galbraith used to say, there is a reason for that. It’s that when the old generation passes away and a new generation comes along, that doesn’t remember those lessons …

CONSUELO MACK: Exactly, exactly.

LIAQUAT AHAMED: … so we had boom times on Wall Street in the late ‘60s and then we went through a long period of fallow years …

CONSUELO MACK: And those animal spirits would generate …

LIAQUAT AHAMED: And I think we’re getting those fallow years on Wall Street now.

CONSUELO MACK: This is a hard turn, but my final question to you, as we always ask each guest on WEALTHTRACK, if there’s One Investment that we should all own some of in a long term diversified portfolio, so you can put on your former fixed income manager’s hat, Liaquat, and tell us what it would be, what would you advice?

LIAQUAT AHAMED: I think the adage that one of the Rothschild’s had, which is, you should buy when there is the sound of canons in the street. And essentially he’s saying, you know, buy when there’s terrible troubles and everything looks …

CONSUELO MACK: Awful. Right.

LIAQUAT AHAMED: … awful. So where does everything look awful? Greece. So I would buy assets in Greece.

CONSUELO MACK: Or an ETF. I’m sure there’s a Greek ETF. Right.

LIAQUAT AHAMED: Yes, yes. Yes. But I suspect that there’s going to be much more opportunity in the private market as private equity firms try and snap up, basically, distressed assets in Europe.

CONSUELO MACK: All right. Well, we will leave it there. Thank you so much, Liaquat Ahamed, for joining us.


CONSUELO MACK: And thank you for your wonderful book, “Lords of Finance.”

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