This article is adapted from the business magazine Capital and is available here for ten days. Afterwards it will only be available to read at www.capital.de. Like stern, Capital belongs to RTL Deutschland.
The banker Jakob Goldschmidt and the wool king Carl Lahusen always bet that everything would be fine and even better. But their friendship as soldiers of fortune collapses on the evening of May 11, 1931. The catastrophe can no longer be stopped. Goldschmidt, the celebrated leader and partner of the second largest bank in Germany, invited Carl Lahusen to dinner this Monday in his magnificent villa at Berlin’s Tiergarten. Lahusen and his brothers run the Nordwolle Group, one of the largest wool processors in the world. But, as people in the financial world whisper, business is no longer going well. Not good at all.
In general, times have become tougher. The recession is never ending. Only the political thugs on the right and left are winning in this crisis. Foreign countries are already withdrawing their money, and just today new bad news arrived from Vienna: Austria’s largest bank is on the verge of collapse.
The banker Goldschmidt is worried. His Darmstadt and National Bank (Danat) lent around 50 million Reichsmarks – four fifths of its share capital – to the Lahusen empire. And now it is said that Nordwolle will end the financial year with a loss of 45 million Reichsmarks.
There will be a lot to talk about at this dinner.
Even before dessert, a third gentleman arrives: Danat director Max Doerner, who comes directly from Bremen. There he spent days digging through the books at Nordwolle. He asks his boss to speak to him in the next room. The findings he brings with him: devastating. The Lahusens have been doctoring their balance sheets for years, most recently engaging in a speculative stock purchase. Your loss is more than three times as high as expected.
Goldschmidt loses his temper. “The Nordwolle is gone!” he shouts. “The Danat Bank is gone! I’m gone!” When he finally returns to Lahusen, who has been left alone, the meal continues in an icy atmosphere. Lahusen cries, makes new promises. The next day, the angry banker throws a chair at his debtor in his office. But why else? Final attempts at cover-up and rescue are made – but eight weeks later both are bankrupt. With them, the world financial system is in free fall.
At other times, the bankruptcy of Nordwolle would have been just a particularly spectacular economic scandal. In the summer of 1931, however, it was one of the last shocks that caused an already overturning international credit structure to collapse – and thus set in motion an unprecedented chain reaction.
Ever since Black Friday on the New York Stock Exchange in the fall of 1929, a recession has eaten its way around the world. The collapse of Nordwolle marks the beginning of an economic hellish journey: the recession turns into mass misery. A fatal drop in prices due to a lack of demand. And an existential crisis for the system.
The revival of the real economy is no longer an issue at the moment, explained economist John Maynard Keynes on New Year’s Day 1932. The problem of the hour is simple: “Can we prevent the financial structure of modern capitalism from almost completely collapsing?”
The deflation, which intensified after the crash in the summer of 1931, is nowhere near as ingrained in the collective memory of Germans as the hyperinflation a few years earlier. But its consequences are even more dramatic: Germany enters the crisis as a shaky democracy – and comes out again as a murderous dictatorship.
It was a fatal mix of debt, politics and mass psychology that almost destroyed the German banking system and fatally poisoned the Weimar Republic: At the end of the Roaring Twenties, Germany was deeply in debt to foreign countries; There were practically no international institutions that could help and mediate payment problems. Instead, old obsessions and fears from the World War, the Treaty of Versailles and the Great Inflation of 1923 still haunted.
There were various reasons for the Germans’ high obligations towards foreign countries. On the one hand, there were reparation payments, an almost constant topic of domestic and foreign policy. The whole country agreed that these burdens were far too high and, in fact, deeply unfair. However, the camps argued bitterly about the right way to shake them off.
Actually, the reparation payments should have led to capital flowing out of Germany – meaning less was consumed than produced and an export surplus was created. In fact, the opposite happened: capital came in. Foreign investors, especially from the USA, were happy to give generous amounts of credit, invested their money in the big banks in Germany and financed German municipalities and companies with high-interest bonds. The influx was so large that it not only compensated for the outflow from the reparations, but even created additional scope.
Whatever was said in politics about the plundering of the nation, in fact Germany lived beyond its means in the best years of the Weimar Republic.
If you add everything up, the international payment flows of the 1920s caused a financial carousel that was as bizarre as it was prone to disruption: Germany paid the hated reparations, more than half of them to France. However, the European victorious powers immediately passed this money on themselves – to the USA, to whom they had to pay off their own, also hated, war debts. Meanwhile, fresh private credit flowed from America back to Germany – which also used it to pay the reparations.
There was no shortage of warnings. In 1927, for example, the then Reichsbank President Hjalmar Schacht was already angry about the wasteful municipalities that were constantly buying new swimming pools, parks and opera houses on credit.
The great vulnerability of German banks and savings banks was also no secret. Not only were there too many financial institutions – they had also lost a large part of their capital due to hyperinflation. Compared to the last pre-war year of 1913, for example, the banks’ equity had shrunk by more than two thirds in 1925, and their debt capital had shrunk by over 80 percent. There wasn’t much left to gain from German savers, so banks financed themselves heavily abroad – and very often at short notice.
The directors themselves knew that something like this did not correspond to the rules of sound banking business. What if the foreigners abruptly withdraw?
But wasn’t it right, after all the post-war misery, to finally give credit again and focus on expansion? Weren’t the chances so good that you could now take a risk? America with its roaring twenties and seemingly limitless prosperity showed that courage pays off.
Jakob Goldschmidt’s Danat Bank forged ahead and was also happy to woo major customers who were shy about their more cautious competitors. Borrowers like the Lahusens with their wool empire, who not only treated themselves to an impressive new country estate and a noble new company palace in Bremen, but also wanted to turn the big wheel in corporate strategy.
The end of this prosperity on credit began a good year before the big October crash of 1929. In America, stock prices rose ever more rapidly, and many US investors preferred to direct their money to Wall Street rather than to faraway Germany, where the economy was slowing. After Black Friday, the funds suddenly ran out completely.
The credit dried up, Germany had to save heavily – and plunged into a spiral of economic decline and disintegration of the republic: the number of unemployed rose quickly, and the SPD-led government coalition collapsed in the dispute over support for them at the beginning of 1930. The new chancellor was the strict Heinrich Brüning from the Catholic Center, who no longer had his own majority in parliament and had to govern with emergency decrees – the trained financial politician was held solely by the power of the national conservative Reich President, the aged World War II general Paul von Hindenburg.
The new, only 44-year-old Chancellor was also responsible for implementing the austerity measures that resulted from the so-called Young Plan – a reorganization of reparation payments that had recently been negotiated with the victorious powers and which was furiously opposed, especially by the political right.
For Brüning, too, the top government goal was to cancel all reparations. However, the open breach of commitments that the extremists loudly demanded was out of the question for him. Germany had to remain creditworthy and capable of doing business.
His own plan was called “Illness as a Weapon”: If Germany showed that foreign demands could not be met even with extreme austerity, the creditors would have to give in.
In terms of domestic politics, however, Brüning’s first maneuvers ended in fiasco: in the new elections in September 1930, which were actually intended to strengthen him, the Nazis triumphed; Overnight they rose from a splinter group to the second largest parliamentary faction. Germany became unpredictable and its financiers were extremely nervous from then on.
With every new bankruptcy rumor and every political crisis, foreigners withdrew money – especially from the big banks. When Austria’s Creditanstalt became insolvent in May 1931, its demise also triggered a new wave of capital flight from Germany.
At the beginning of June, turmoil surrounding Brüning’s harsh austerity package further aggravated the situation. Especially since his government published an “appeal” that was read abroad as a threat of national bankruptcy: “The limit of the deprivations we can impose on our people has been reached!” it said. “The conditions under which (the Young plan) came about have proven to be erroneous.”
The austerity measures had long since begun to slow down the economy. Expenses fell, investments, wages – and slowly prices too. In mid-June, amidst this onset of deflation, the bomb exploded, which the banker Goldschmidt and the wool king Lahusen were no longer able to defuse: Nordwolle publicly admitted its difficulties. The run was on: According to the motto “Save yourself if you can!” Capital stormed out of German banks abroad and into other currencies.
The central bank’s reserves dwindled rapidly because under the gold standard monetary system at the time, it was obliged to issue dollars, pounds or francs at fixed exchange rates for every mark submitted. But it then had to purchase this foreign currency from the other central banks at a fixed rate in exchange for gold.
The government and the Reichsbank tried desperately to restore trust and maintain capital. A drastic interest rate increase had some effect, and on June 20th there was even a seemingly redeeming gesture from America: President Herbert Hoover proposed a moratorium on all intergovernmental debt. The beginning of the end of reparations was here!
But the central credibility problem remained. How should you convince panicked bank customers that they could be paid out in any case? Simply creating new money, as central banks do today, was impossible for Reichsbank President Hans Luther: the rules of the gold standard did not allow it – the notes in circulation always had to be backed by a minimum amount of the precious metal. The actual gold coverage, however, was rapidly approaching the red line: on June 23rd it was just 0.4 points above the prescribed lower limit of 40 percent.
The only salvation now would have been generous credit lines from other countries. But the British themselves had long been cash-strapped and the Americans still had to sort themselves out. The French demanded foreign policy concessions; Such a combination was out of the question for the nationalist leadership in Berlin – so no help was provided.
The dramatic hours of truth come on the second weekend in July: Goldschmidt had recently confessed to Brüning that the Danat Bank was liquidated, and the Rhine Province’s Landesbank also reported on Friday evening that it was illiquid. From Saturday lunchtime to early Monday morning, one crisis meeting followed the next in the Reich Chancellery.
In constantly changing rounds, in which almost the entire top of the German banking world takes part, emergency plans are discussed and decided, then rejected and then decided again. Numbers are given and corrected, promises are made and restricted again. The German financial elite is fighting on the edge of the abyss for two days – and not everyone is looking good. “Seldom have the differences in thinking skills and attitudes been revealed to me as much as in these hours,” Finance State Secretary Hans Schäffer later wrote.
Brüning no longer trusts the big banks because they all lied to him about the condition of Nordwolle. He brings in former Reichsbank boss Hjalmar Schacht, among others, to advise him, but he now has little to offer him either. Schacht, who was already flirting politically with Hitler at this time, cynically lets the Chancellor know that he had long been warning about the bankers: “All the people sitting across from us here are criminals. They were all bankrupt in 1926.”
Brüning himself, of course, also had his weaknesses and wanted to do everything on his own. “Out of a sense of responsibility, he tended to complicate things enormously, only to repair the ruins with the greatest of efforts afterwards,” judged contemporary journalist Richard Lewinsohn. “For all his devotion to God, he was possessed by an unparalleled arrogance that concealed itself behind an ascetic reserve until it finally broke through in a military command tone.”
When some ministers and state secretaries went home at two o’clock on Monday morning, Brüning had them brought out of bed again. Finance Minister Hermann Dietrich quipped that the fugitive gentlemen had probably wanted to avoid the final vote.
In the back and forth of the crisis round, it becomes clear that the bankers would prefer to present the disaster as an isolated case: as a problem for Danat, which, as an aggressive newcomer, is already unpopular with its competitors – especially with the bosses of Deutsche Bank, who claim to be… see the true guardians of a solid credit economy.
“Everyone believed that they could save themselves from a crisis of this kind by denouncing someone else,” Brüning later wrote in his memoirs. “It was a terrible realization for me, because now I saw that all of these personalities were narrow-minded and had no idea of the inevitable side effects, especially the psychological collapse of depositors, in every banking crisis.”
Deep into the night, the government still decides to just close the Danat Bank counters and reassure its customers with a state guarantee. This immediately turns out to be a mistake: As soon as people gather in front of the Danat branches on Monday morning, people storm the other open institutes.
On the evening of July 13th, the government ordered “bank holidays”: all financial institutions must close for two days, payment transactions will remain restricted for weeks, and the stock exchange will be closed until the beginning of September. The free movement of foreign exchange is abolished and replaced by compulsory state management; Later, a “Reich Flight Tax” was added.
But the bad news continues for now: Dresdner Bank, whose board was still liquid on Sunday, is also reporting illiquidity; It must later be merged with Danat and – like Commerzbank – nationalized. In view of the chaos, many foreign banks are canceling all their loans in Germany.
The earthquake that struck Berlin in July 1931 kept the financial world in suspense for many months. Bank crashes and national bankruptcies are sweeping across Eastern Europe, the Middle East and South America. As the British pound came under increasing pressure, on September 19th the Bank of England announced the previously unimaginable: the end of its currency’s gold convertibility.
The previous anchor of the world financial order has been broken, and the pound has depreciated by a good quarter. Many countries are following suit, giving up the gold peg and pegging their currency to that of the British. The new sterling block will soon have clear price advantages for export due to its favorable exchange rate.
In Germany, on the other hand, politicians continue to doggedly try to maintain the austerity measures and draw the first conclusions from the scandals: the government fires the boards of directors of the nationalized banks, sets up a banking supervisory authority, and issues stricter rules for corporate control. Among other things, the number of supervisory board positions per person is limited to a maximum of 20 – Danat boss Goldschmidt once had 123. The cross-talk on supervisory boards that had been common until then will also be banned. The bosses of Nordwolle and Danat Bank, for example, conveniently (did not) control each other.
During this time, however, the economic crisis grew into a social catastrophe: in February 1932, the number of unemployed reached its peak of over six million. A third of the German working population and their families live on meager resources; Misery and political violence dominate the cities.
When President Hindenburg, who was pushing to the right, dropped his “Hunger Chancellor” Brüning in the spring of 1932, his main goal was almost achieved: the cancellation of reparations was imminent. The economic low point has also been overcome after brutal spending cuts, tax increases and the forced reduction of wages and prices: the trade balance is positive, the budget deficit has been significantly reduced, and a recovery is in sight. Brüning later always complained that he fell “a hundred meters from the finish line”.
Nevertheless, history has not been kind to the ascetic emergency decree politician. To this day, the name Brüning is associated with the accusation of having pursued an ideologically blinded austerity policy that only exacerbated recessions. A criticism derived from this even appears in the euro debates: in all the inflation hysteria, the Germans have probably forgotten that Hitler’s rise to power began because brutal deflation was permitted, even forced.
The criticism of Brüning is now theoretically well justified. But it is historically skewed. Brüning and his colleagues were well aware of the bitter consequences of their policies. But they only had a narrow scope for action: under the constraints of the Young Plan and the rules of the gold standard, there was hardly any opportunity to stimulate domestic demand. This would only have been possible with international help.
When the restrictions relaxed in the fall of 1931, those responsible in Berlin shied away from the risk. A devaluation like that of the pound sterling would have stimulated exports – but at the same time it would have increased the burden of all the debts that had to be serviced in foreign currencies.
Germany’s situation at the time is in some ways similar to the situation in Greece today: Anyone who has to reduce domestic consumption after a credit-financed false boom, is dependent on nervous lenders abroad and cannot pursue their own monetary policy – there is little choice but harsh austerity. And the hope of quick debt relief. Everything else is only possible if the current rules of the game are radically thrown out of the window.
Brüning’s deflation policy ultimately corresponded to the usual recipe in the gold standard system. In everyday life, the slow decline in prices was not seen as much of a catastrophe as the earlier hyperinflation. Millions suffered from unemployment, wage and social cuts. They welcomed the fact that many things became cheaper.
At the same time, however, the fear of a new devaluation of money was by no means overcome. Even if it may seem absurd today: While the price level in Germany fell by around a fifth between 1930 and 1932, fears of inflation were widespread. The trauma of 1923, when the debtor state rehabilitated itself by wiping out the financial assets of the bourgeoisie, was after all less than ten years ago. And the future was now unpredictable again.
It seemed obvious to switch to dollars or real assets. However, if there was a mass exodus of the population from the Reichsmark, the money would actually have suddenly been devalued.
The writer Carl Zuckmayer, who happened to be in Berlin in July 1931 and wanted to withdraw money, described how great the general confusion was in the country. In front of the closed banks he was “surrounded by excited, swearing or complaining people who were worried about their savings.” It was no wonder, he noted, that empty Nazi phrases such as “‘breaking interest slavery’ were eagerly absorbed by these disturbed people.”
Not only the poorest, but also the middle class had lost trust in politics and the economy as a result of the crisis. People felt let down, Zuckmayer wrote: “For average Germans, there seemed to be something healthy and powerful in the Nazi leaders’ enormous appetite for power and violence that promised a glimmer of better times.”
Only a year and a half later, the new Chancellor was Adolf Hitler.