Tuesday, April 27, 2010

Great Moments in Western Civ II

We covered the Dawes Plan in class the other day.

The Dawes Plan is easily my favorite historical event of the 1920s, because it is sublime in its absurdity. It took what was a dysfunctional and ridiculous system of international finance and converted it into a functional but no less ridiculous system of international finance, and you have to admire the artistry of that. It takes a special mind to be able to take something goofy and obvious and understand that it might work anyway.

Charles Dawes was an American banker. He had served in the Harding Administration as the Chairman of the Bureau of the Budget, bringing sound accounting principles to the federal government for what might well have been the first time. It was Dawes who established the General Accounting Office, which serves as a watchdog for federal spending even today. By 1924 he had left the federal government and gone back into private industry. But then his nation called him back to service, to the everlasting gratitude of those of us who teach for a living and require stories to keep our students entertained.

The situation Dawes faced was this:

By 1923, it was clear that Germany could not possibly keep up with the reparations payments demanded of it by the Treaty of Versailles, which had ended WWI. Essentially, Britain and France had demanded that Germany reimburse them for the costs of the war - which they declared to be entirely Germany's fault, much to the surprise of anyone who actually had a clue about how the war began - and forced Germany to sign what was, more or less, a blank check at the Paris Peace Conference in 1919. The actual amount of reparations was not set until 1921, and it was set impossibly high.

And when Germany did try to pay those reparations, it destroyed the German economy. The only way it could pay the reparations was to print money, and, not surprisingly, the German mark collapsed forthwith. In 1921, when the amount was set, the German mark was trading at about 64 to the dollar. By 1922 it was 191 to the dollar, and in 1923 a dollar could buy you 17,972 marks in January, 110,000 marks in August, and 4,000,000,000,000 marks in November. This clearly was not working.

But the French and British needed the Germans to pay those reparations. They ended the war in hock up to their eyeballs to the US, which emerged from WWI as the world's largest creditor nation. The US wanted that money back. The problem was that the war had bankrupted the British and French, and the only way they could make payments on their war debts was to use reparations money, money that Germany could not pay.

This is not a recipe for financial stability.

At this point, I like to think that Dawes had a grandchild - a young one, maybe six years old - who listened to the old man complain at dinner one evening and then made a simple suggestion. And I'm sure that Dawes patted the child on her head and said something like, "Well, thank you, my dear, but you see, we can't really do that because ... I mean, that would be impossible bec... wait, why can't we do that?"

Because what the Dawes Plan basically says is, "Why doesn't the US just loan money to Germany?"

The Germans could use those loans to make their reparations payments to the British and the French. The British and the French could funnel that money back to the US as payments on their war debts. And then we could loan it back to the Germans, and the cycle could start all over again.

This is brilliance itself.   For the price of two or three payments - which the US could well afford in 1924 - the problem goes away!

When you draw that third arrow on the board, by the way, the one that goes from the US to Germany, students just gasp. It's one of my favorite moments in Western Civ II.

On the plus side, the Dawes Plan stabilizes the international system of finances, buys the Germans time to get their economy back in order, and eventually - if it is allowed to work long enough - cuts the British and French out of the system entirely. If you go around that circle enough times, all the reparations and war debts get paid and all you are left with is bilateral US/German debt, debt that doesn't have the emotional baggage of war debts or reparations and can therefore be treated rationally at some future point.

On the down side, though, it does mean that the entire international financial system is dependent on the health of the US economy, which becomes problematic in October of 1929. It's not coincidence that the two countries most hard hit by the Great Depression are the US and Germany.  But you can't blame Dawes for not seeing the Depression coming, I think.  Not many people did.

So three cheers for Charles Dawes, I say, for having the vision to do the absurd when the absurd was the right thing to do.

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