The Bank Behind Central Banks
History of a bank that influences Central Banks globally and which had once financed the Nazis but you have probably never even heard of it
Picture: Bank of International Settlements(BIS) headquarters building in Basel, Switzerland (Source:
BIS.org
)
Central Banks are institutions that manage the monetary policy of a country or as in the case of Europe, a monetary union. They have an absolute monopoly over the currency and money supply which they achieve by being the regulator of the banking system. As such one would imagine that they are owned and operated by the government. Although that is now true in many cases, it was not always that way. The nationalization of these institutions started in the 1930s with the Bank of New Zealand and the Bank of France. It continued with the Bank of England being nationalized in 1946 and the Reserve Bank of India in 1948. The Federal Reserve Bank of the US still follows a hybrid model where the banks that it regulates hold majority ownership of its regulator.
Blame it on this lineage of being once independently owned or on the nature of its responsibilities, but Central banks and Central bankers have long valued their independence and their operating autonomy¹. Since controlling the currency involves controlling its foreign exchange rates, heads of Central Bankers often have a good rapport and in some cases close friendship with their counterparts from other countries.
The aftermath of World War I
It was June 1919, when delegates from the Allied powers which included Great Britain, France, Russia, and the United States, signed a Treaty with delegates from Germany and other countries in the Hall of Mirrors of the Palace of Versailles outside Paris. The Treaty of Versailles required Germany to accept responsibility for causing all the loss and damage during the war. Germany had to agree to pay the Allied powers reparations for the war. The amount was determined by the Reparations committee in 1921 to be 132 billion gold marks, which would be roughly half a trillion US dollars in 2020. The German economy was in shambles, its infrastructure destroyed, its working population exhausted, and its currency worthless.
Unlike Britain and France who had partially funded the war by increasing taxes and the rest from debt, Germany had completely relied on debt from domestic and foreign sources for its war finances. It had hoped to repay the debt by using the wealth from its enemies once it won the war. Unfortunately for them, they lost the war and were left with a depleted gold reserve, a mountain of debt, and an impossible reparation bill. Printing of currency against a non-existent gold reserve cause hyperinflation which made one US dollar worth 4,210,500,000,000 German marks. Something had to be done.
Rise of Hjalmar Schacht
Picture: Hjalmar Schacht, 1958 (Source:
Encyclopædia Britannica
)
In November 1923, Hjalmar Schacht who was an ex-journalist and banker with international contacts in the banking world was made the Currency Commissioner of the German Reich. He immediately controlled the supply of the Rentenmark, Germany’s post-war currency. A new Rentenark was issued which was equal to one trillion old marks. This move helped with some economic stabilization. Prices lost ten zeroes when they were denominated in the new marks and public confidence in the currency slowly inched up. Schacht was made the President of the Reichsbank, Germany’s central bank in 1924. He introduced a new currency called the Reichsmark soon after. By the end of the year, one dollar was equivalent to 4.2 Reichsmarks. Schacht had succeeded in saving Germany from runaway inflation but he still had to pick up the tab for reparations.
Between 1924 and 1928, American banks and investors invested millions of dollars in Germany. This money helped to restart the economy but most of it was used to pay reparations to the Allied countries who themselves paid it back to the US to repay their war debt. In 1929, Wall Street crashed and the US slipped into the great depression and the flow of money to Germany once again ran dry. A new round of political discussions under the chairmanship of Owen Young started between France and Germany in the Hague over how Germany was now going to continue paying reparations.
The Bank of International Settlements is born
Schacht was friends with Sir Montagu Norman, the Governor of the Bank of England. They had met on numerous occasions during their tenures as the head of the Central Banks of their respective countries. Schacht and Norman envisioned a new Bank to manage the reparation payments. A bank that would be free from political interference and would purely work towards financial goals. A bank that would coordinate loans to underdeveloped countries so that they can buy the goods produced by Germany. They pitched this idea of a new bank at the conference at Hague. By the end of the conference not only was the proposal accepted but Schacht negotiated to reduce Germany’s reparation liability significantly.
Picture: Hjalmar Schacht(left) and Montagu Norman(Right) (Source:
The Telegraph
)
The Bank of International Settlements(BIS) was formed with the objective to “promote the cooperation of central banks²” enshrined in its statutes. The plan was for the bank to hold gold and other securities for Central Banks and help settle international payments, effectively becoming a clearinghouse.
The Bank was incorporated under Swiss law. Its initial capital came from Central Banks of Britain, France, Germany, Italy, and Belgium as well as private banks from the US like JP Morgan, First National Bank of New York on behalf of the Federal Reserve Bank, and the US. Its Board comprised of the Governors of these Central Banks.
Independent and secretive money making machine
Schacht and Norman had designed a bank with superpowers. It was an international organization legally immune, and away from any country’s political reach.
“The Bank, its property and assets and all deposits and other funds entrusted to it shall be immune in time of peace and in time of war from any measure such as expropriation, requisition, seizure, confiscation, prohibition or restriction of gold or currency export or import, and any other similar measures”² — Article 10 of BIS charter
Any profits that the bank made was and continues to be exempt from taxes. Any deposits that the bank holds are also exempt from taxation.
Norman wanted the bank to be a cozy club of Central Bankers. A place where they can meet, discuss policy decisions, and exchange notes without any political influence or interference. Thus all practices of the bank were designed to uphold this veil of secrecy. Its building bore no signs and it was impossible for someone to imagine that a nondescript building in Basel was being used to facilitate settlements of billions of dollars. Most of its meetings were never announced and the decisions made were never published.
The BIS's main purpose was to settle international funds for Germany’s reparation payments. When Germany wanted to pay reparations to England, they would make a deposit with BIS. BIS would inform Britain about the deposit and if Britain did not withdraw the money, it was invested by BIS to make profits. Since the payments were so huge, many countries did not move them for the fear of unsettling the currency exchange rates, and this allowed BIS to make huge profits off the investments. But soon the BIS went beyond just German reparations and started accepting other countries. By the end of 1931, twenty-three Central Banks joined the BIS including the small new country of Czechoslovakia.
The Nazi Affair
After having successfully annexed Austria, Adolf Hitler set his eyes on Czechoslovakia next. In order to avoid a war, Britain and France diplomatically pressurized Czechoslovakia in September 1938 to secede its region of Sudetenland to Germany under the Munich agreement. In the next few months, Poland annexed some territories and Czechoslovakia was left fragmented and weak. Hitler took advantage of this and ordered his troops to take over Prague in March 1939. This was a violation of the Munich agreement and naturally, Britain prepared to go to war with Germany.
The Czechoslovakian gold reserves were held in the Bank of England in an account under the name of the BIS. When the Nazis marched into Prague, they immediately sent soldiers to the offices of the National Bank of Czechoslovakia. The soldiers forced bank employees to send transfer requests to London. The order transferred 23.1 metric tonnes of gold from the Czechoslovak BIS account to the Reichsbank BIS account. Norman saw to it that the procedures were followed and the order went through. This action caused a huge uproar in the parliament and the press had a field day. Nazi Germany had won a huge battle without a shot being fired.
This is where the nature of BIS and that of the Bank of England at the time becomes evident. As independent and private institutions, they valued trade and international financial cooperation above political equations and even human costs in some cases. Even during the war, when the rest of the allied world stopped trade and actively embargoed Nazi financial deals, the BIS continued to carry out foreign exchange deals for the Reichsbank and lending them money. The Reichsbank continued paying interest on these loans to the BIS. This interest was used by the BIS to pay dividends to shareholders, which included the Bank of England⁴.
The BIS today
Today, the BIS remains active and very profitable. Its 2019 Annual Report reveals a net profit of USD 639.5 million.
Every two months, it hosts a meeting for the heads of the Central Banks of the world’s sixty major economies. These bi-monthly meetings along with an Annual meeting are held to advance their mission of ‘fostering discussion and facilitating collaboration among central banks’.
All those Central Bank Governors fly to Basel, every two months. The minutes of those meetings are not published so it is very hard to guess what they really discuss there, but whatever it is, it drives policy decisions in your country.
The BIS remains a strong but rather inconspicuous pillar of the monetary world.
PS: Off late, they seem to be working on coordinating the Central Bank Digital Currencies(CBDC) action with multiple Central Banks. So we will have to wait and watch how that plays out.
References
[1] Richard N. Cooper, Almost A Century of Central Bank Cooperation
[2] Constituent Charter of the Bank for International Settlements
[3] Adam Lebor, Tower of Basel
[4]Adam Lebor, How bankers helped the Nazis
[5] BIS, Annual Economic Report
You just read the seventh essay in the series ‘An Inquiry into Money’.
If you enjoyed reading this post, do come back in two weeks for another.
If you haven’t yet, subscribe now to have these essays delivered to your inbox and tell your friends about it.
I also publish this series on Medium.