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Keynes was right on the key issues
on 3 July 2011
Having read the "General Theory" many years ago as an undergraduate, I decided it was time to read "Economic Consequences of the Peace". Keynes attended much of the conference and wrote fascinating pen-portraits of the main players - Clemenceau believing in the inevitability of eternal conflict and wanting a Carthaginian Peace; Wilson having high moral principles but insufficient intellect to stand up to Clemenceau; and Lloyd George converted to an ever more oppressive treaty by the need to win an early general election in Britain. These pen-portraits alone make the book worth reading, but of much greater interest is the analysis of the terms of the Peace.
In my judgement the key observations Keynes made in this book about the state of Europe in 1919 and about the Versailles Treaty were:
1. Not only Germany but also much of Europe (excluding Britain) was in a poor economic condition and would find recovery difficult.
2. One particular factor he noted was the existence of inflation and the danger of it continuing, worsening and damaging economies. He said the problem was serious throughout Europe and particularly Germany, which already had a large budget deficit.
3. The Treaty contributed nothing towards creating a fair, functioning and integrated economic system in Europe.
4. The Treaty breached the terms of the Armistice Agreement in the level of reparations and territorial adjustment, which was morally reprehensible. Germany had not surrendered unconditionally but was treated as though she had.
5. Germany could not possibly pay the full amount of reparations on given knowledge and all reasonable assumptions about the immediate economic future. In addition reparations were unfair in that unlike an indemnity the amount was unknown and unknowable.
6. The combination of points 4 and 5 (plus the obnoxious and inaccurate "war guilt" clause) meant that Germany would feel victimized and betrayed, whereas the Treaty should have sought the reconciliation of nations. Keynes predicted a future war.
The only point on which one might conceivably say that Keynes was not fully vindicated was the first: much (but not all) of Europe boomed in the 1920s. However, it can be argued that Keynes was not fundamentally wrong even on this issue. Those who believe there were structural weaknesses in the major economies, or who follow the line of the Austrian School in arguing that the Great Depression arose from an expansion of the money supply in the 1920s that artificially inflated the economy with an inevitable slump to follow the boom, will argue Keynes was right about the fragility of European economies.
Among the dissenting voices to the view that Keynes was largely correct on almost all issues was Étienne Mantoux, who in 1945 wrote "The Carthaginian Peace, or the Economic Consequences of Mr. Keynes". Mantoux ignored almost all the six points listed above and concentrated instead on showing that German coal and iron production were higher than Keynes predicted, and that Germany was better off than he supposed. However, Mantoux's figures are all based on the actual inter-war situation, where Germany paid only one-eighth of the reparations and developed with the aid of American loans, whereas Keynes' predictions depended on the Allies squeezing Germany until the pips squeaked. In addition Keynes had stressed that predictions cannot be perfect, and changing circumstances change outcomes.
Keynes was correct in his assessment of the effect of reparations and the weakness of Germany in 1919, for when the Allies attempted to extract maximum payments in the years 1919-23 Germany suffered from economic disasters without parallel in a democracy. With a desperate economic situation and unable to pay reparations, Germany suffered the occupation of the Ruhr by the French in January 1923. It meant that Germany had no goods to trade. The result was that Germany resorted to printing (even more) money to repay reparations and loans. This led to hyperinflation. Keynes was also vindicated in his prophecy of inflation elsewhere in Europe by the inflations in Danzig, Estonia, Hungary, Latvia, Poland and Russia. Mantoux's specific points about iron and steel not only ignored the fact that the production was with the aid of US loans and the non-payment of reparations, but also ignored myriad other contrary economic indicators, including not only the 1923 hyperinflation but also the fact that Germany had 30% of its workforce unemployed in 1932.
Keynes was correct in saying that the Treaty would not bring peace. A hatred of the Treaty and the oppressive French occupation of the Ruhr helped to undermine the Weimar Republic, bringing Hitler to power and precipitating the Second World War. Keynes played a role in the settlement after the Second World War. His words of wisdom about the failures of the Versailles Treaty were heeded, and principles of cooperation and rebuilding meant a prolonged period of peace and prosperity in Europe after 1945 - a striking contrast to the failure of Versailles to achieve this.
Finally, it has been claimed that the book created (or at least encouraged) appeasement in the 1930s by convincing Britain and the US that the Treaty was unfair to Germany. This is impossible to prove. More important in creating sympathy for Germany was the French occupation of the Ruhr 1923-25, and the main causes of appeasement were anyway miscalculation and the desire for a quiet life among people who had lived through the horrors of the 1914-18 war. It should be noted that Keynes was one of the earliest and most passionate opponents of appeasement. On this too Keynes was proved right.