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The Economic Consequences of the Peace: 100 Years Later

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December 12, 2019 is the hundred-year anniversary of The Economic Consequences of the Peace by John Maynard Keynes. This work has been described as “one of the most influential books of the twentieth century.”1 It made Keynes the most famous economist in the world, and it was the basis of his massive influence on twentieth-century economics. Many of Keynes’s harshest critics view it as his one good book. However, the case can be made that The Economic Consequences of the Peace is his worst book. On its centenary, it is proper to reassess the work and its influence.

Britain’s War-Debt Problem

To truly understand The Economic Consequences of the Peace, it must be realized that the First World War devastated Britain financially. Britain was the world’s financial superpower prior to 1914, but the war changed this. During the war, Britain assisted her European allies by making massive war loans. At the end of the war, France, Russia, Italy, Belgium, and Serbia were deeply indebted to Britain.

Given the scope of the Great War, however, Britain did not have the financial capacity to finance the Allied war effort by herself. Consequently, the British became totally dependent on the United States for financing. In effect, the British borrowed from the United States and re-lent the money to her riskier allies. According to Keynes, “Almost the whole of England’s indebtedness to the United States was incurred, not on her own account, but to enable her to assist the rest of her Allies.”2

At the end of the war, the Allies were heavily indebted to Britain, while Britain was heavily indebted to the United Stated. As Keynes wrote, “the war ended with everyone owing everyone else immense sums of money. … The Allies owe a large sum to Great Britain; and Great Britain owes a large sum to the United States.”3 In The Economic Consequences of the Peace, Keynes estimated the net debt position of the Allies using official Treasury figures.4

Keynes Chart

As the table above shows, the British were in a perilous financial position at the close of the war. Britain had to repay the United States, but the shattered Allies could not repay Britain. This debt-vice is the key to The Economic Consequences of the Peace.

Keynes’s defenders neglect a vital question: who was responsible for orchestrating Britain’s war-debt problem? The answer is Keynes. He started work at the British Treasury in January 1915, and he was transferred to the First Finance Division in May of that year. In May 1917, he became chief of the A Division, newly created to manage all of Britain’s inter-allied lending and borrowing. By the end of the war, he was the third-highest-ranking official in the British Treasury. 

Keynes boasted, “I was in the Treasury throughout the war and all the money we lent or borrowed passed through my hands.”5 He reported, “I happen to have been during the war the Treasury official most directly concerned with the borrowing and the spending of the money.”6  Roy Harrod, an unabashed defender of Keynes, admits: “He occupied the key position at what was without challenge the centre of the inter-allied economic effort, he thought out the policy, and in effect bore the ultimate responsibility for the decisions.”7

Keynes was the British Treasury’s chief representative at the Paris Peace Conference of 1919. His overarching goal at the conference was to solve the war-debt problem he had masterminded. As will become clear, his main solution was war-debt cancellation. On November 29, 1918, he submitted an official memorandum called “The Treatment of Inter-Ally Debt Arising out of the War.” Unfortunately, this crucial document was not published in Keynes’s collected writings. The document is reproduced in the appendix below. We read,

At the opening of the Peace Conference, this country should propose to the United States that all debts incurred between the Governments of the Associated countries prior to January 1st, 1919, should be cancelled. … Failing such a settlement the war will end with a net-work of heavy tributes payable from one Ally to another. A certain amount of indemnity will be recoverable from the enemy, but this is likely to be of a less amount than the indemnities which the Allies will be paying to one another. This is an improper conclusion to such a war as the present one. … Indeed, failing a readjustment, the financial sacrifice of the United States will have been disproportionately small, and Germany will be the only Power free from the financial grip of the U.S.8

Keynes was obsessed with war-debt cancellation at the conference. His American counterpart, Thomas W. Lamont, reported: “The question [of cancelling war-debts] in one form or another constantly arose. It was always ‘stepped on’ by the American delegates.”9 Naturally, the Americans violently opposed war-debt cancellation, for it would shift the financial burden of the war from Europe to America. Austen Chamberlain, the Chancellor of the Exchequer, wrote to Keynes:

No doubt it would be a very good thing if the United States would propose or support a universal cancellation of debt, but my information from Paris is that they show no inclination to do anything of the kind. … To propose the mere cancellation of debt looks as if we were trying to shift the whole burden on to America.10

Keynes left Paris in June 1919 and published The Economic Consequences of the Peace in December. Again, his main policy was war-debt cancellation. He described the “Settlement of inter-Ally indebtedness” as “an indispensable preliminary.”11 He wrote,

If all the above Inter-Ally indebtedness were mutually forgiven, the net result on paper (i.e. assuming all the loans to be good) would be a surrender by the United States of about $10,000,000,000 and by the United Kingdom of about $4,500,000,000. France would gain about $3,500,000,000 and Italy about $4,000,000,000. But these figures overstate the loss of the United Kingdom and understate the gain to France. … [T]he relief in anxiety which such a liquidation of the position would carry with it would be very great. It is from the United States, therefore, that the proposal asks generosity.12

Keynes was desperate to cancel war debts throughout the 1920s and early 1930s.13 However, his cancellation scheme was doomed to repeated rejection. The Americans were afraid that the massive losses from cancellation would devastate the US financial system. But Keynes was incapable of seeing the problem from the American perspective. To his insular mind, anything that was good for Britain must be good for the world.  

German Reparations

According to the conventional wisdom, Keynes was a great opponent of German reparations. In reality, he was the single most important reparations planner at the Paris Peace Conference.

Before the conference, Keynes split the reparations liability into two parts: (1) an upfront payment and (2) a series of long-term payments made over a period of decades. First, Keynes demanded a large upfront reparations payment from the Germans. His main concern was to obtain Germany’s gold reserves, merchant marine, and imperial possessions. He wrote,

Germany is liable up to the full extent of the injury she has caused to the Allied and Associated Nations. … The Allied and Associated Governments demand accordingly that Germany render payment for the injury which she has caused up to the full limit of her capacity. … Germany shall hand over immediately (a) the whole of her mercantile marine, (b) the whole of her gold and silver coin and bullion in the Reichsbank and all other banks; (c) the whole of the foreign property of her nationals situated outside Germany, including all foreign securities, foreign properties and business and concessions.14

On top of the large upfront payment, Keynes recommended imposing a long-term liability. In fact, the evidence shows that Keynes originated the idea of imposing long-term reparations on Germany. He first recommended a long-term liability in a joint memorandum with William J. Ashley dated January 2, 1916 and entitled “Memorandum on the Effect of an Indemnity.”15 Lloyd George confirmed, “Professor Ashley and Mr. Keynes are thus the joint authors of the long-term indemnity which was incorporated in the Treaty.”16

Keynes conceived the plan to impose long-term reparations on the Germans, and he started estimating Germany’s capacity to pay long before the end of the war.17 But at the conference, he concluded that it was impossible to estimate Germany’s capacity to pay each year. His solution was to leave the amount of reparations unfixed in the treaty. Instead, he called for the establishment of a committee to set the annual reparations bill year by year. In short, it was Keynes’s disastrous idea to not fix the amount of reparations in the treaty.18

In the armistice, the Germans agreed to restore the territory they had invaded. Since the entire war on the Western front was fought in France and Belgium, the armistice gave these nations a legal basis for imposing reparations on Germany. By contrast, the Armistice did not entitle Britain to German reparations. Thus, at the conference, the British contrived the notorious war-guilt clause, Article 231 of the Treaty of Versailles, to provide a legal basis for British claims to reparations. Along with John Foster Dulles, Keynes was the author of Article 231.19

As noted, Keynes recommended war-debt cancellation in The Economic Consequences of the Peace. This would solve the war-debt problem. But he also advocated imposing short- and long-term reparations on the Germans. This means the reparations he advocated in The Economic Consequences of the Peace were not designed to alleviate Europe’s financial problems. Instead, the reparations were punitive: 

(1) The amount of payment to be made by Germany in respect of Reparation and the costs of the Armies of Occupation might be fixed at $10,000,000,000

(2) The surrender of merchant ships … war material … State property … public debt, and Germany’s claims against her former Allies, should be reckoned as worth the lump sum of $2,500,000,000

(3) The balance of $7,500,000,000 should not carry interest pending its repayment, and should be paid by Germany in thirty annual installments of $250,000,000, beginning in 1923.20

The Transfer Problem

Clearly, it is absurd to claim that Keynes opposed German reparations; he was the single most important architect of the reparations settlement. Beyond that, he continued advocating German reparations after the treaty. So why is he so commonly considered an opponent of German reparations? The answer is the transfer problem.

Advocates of the transfer problem argued that Germany’s annual reparations payments would stimulate her exports. In this view, Germany could only raise the money needed to pay reparations by exporting her goods abroad. But Britain was Germany’s chief competitor in export markets. To those who believed in the transfer problem, a large annual reparations liability posed a threat to British export industries. Keynes wrote,

Two eventualities have to be sharply distinguished; the first, in which the usual course of trade is not gravely disturbed by the payment. … The second, in which the amount involved is so large that it cannot be paid without a drastic disturbance of the course of trade and a far-reaching stimulation of the exports of the paying country. … An indemnity high enough to absorb the whole of Germany’s normal surplus, for investment abroad and for building up foreign business and connections must certainly be advantageous to this country and correspondingly injurious to the enemy.21

Keynes’s belief in the transfer problem led him to play a balancing act. On one hand, he wanted the British to receive enough from Germany each year to cover Britain’s annual debt payments to the United States. On the other, he did not want the annual payments to be too large, for this would to stimulate German exports at Britain’s expense. To Keynes, the best strategy was

to obtain all the property which can be transferred immediately or over a period of three years, levying this contribution as ruthlessly and completely, so as to ruin entirely for many years to come Germany’s overseas development and her international credit; but having done this … to ask only a small tribute over a term of years.22

He wrote later,

We can secure from her moderate [annual] payments, on the sort of scale, for example, on which she might have been building up new foreign investments, without stimulating her exports as a whole to a greater activity than they would enjoy otherwise. This is the correct course for Great Britain from the standpoint of her own self-interest only.23

Superficially, it looks like Keynes recommended modest annual payments out of humanitarian concern for the Germans. But once the transfer problem is considered, it is clear that he recommended modest payments to stifle Germany’s international development. Paradoxically, for a believer in the transfer problem, large annual reparations payments would have helped Germany recover from the war. This was not Keynes’s goal, however. Instead, his goal was to prevent Germany from reemerging as an economic rival to the British Empire. He wrote,

We, who are imperialists … think that British rule brings with it an increase of justice, liberty, and prosperity; and we administer our Empire not with a view to our pecuniary aggrandizement. … Germany’s aims are not such. … [S]he looks rather to definite material gains. … [W]e distrust her diplomacy, we distrust her international honesty, we resent her calumnious attitude towards us. She envies our possessions; she would observe no scruple if there was any prospect of depriving us of them. She considers us her natural antagonist. She fears the preponderance of the Anglo Saxon race.24   

The transfer problem was the economic theory underlying all of Keynes’s work on reparations before, during, and after the Paris Peace Conference. But Keynes’s theory of the transfer problem is a fallacy; the transfer problem does not exist. Even Robert Skidelsky, a zealous Keynesian, confesses, “If we stick to the pure theory of the matter, Keynes was wrong.”25 Ludwig von Mises explains,

An excess of exports is not a prerequisite for the payment of reparations. The causation, rather, is the other way round. The fact that a nation makes such payments has the tendency to create such an excess of exports. There is no such thing as a “transfer” problem. If the German Government collects the amount needed for the payments (in Reichsmarks) by taxing its citizens, every German taxpayer must correspondingly reduce his consumption either of German or of imported products. In the second case the amount of foreign exchange which otherwise would have been used for the purchase of these imported goods becomes available. In the first case the prices of domestic products drop, and this tends to increase exports and thereby the amount of foreign exchange available. Thus collecting at home the amount of Reichsmarks required for the payment automatically provides the quantity of foreign exchange needed for the transfer. … The inflow of Germany’s payments necessarily rendered the receiving countries’ balance of trade “unfavorable.” Their imports exceeded their exports because they collected the reparations. From the viewpoint of mercantilist fallacies this effect seemed alarming.26

The transfer problem is the economic theory on which The Economic Consequences of the Peace is based. However, Keynes’s mercantilist theory of the transfer problem is incorrect. In the end, The Economic Consequences of the Peace was rooted in a tissue of mercantilist fallacies.   

Reassessing the Mythology

According to the conventional wisdom, Keynes valiantly resigned from the British delegation in protest against the severe reparations imposed on the German underdogs. As Skidelsky claims, “He resigned in June 1919, just before the Versailles peace treaty was signed, in protest against the allied determination to extract huge reparations from Germany.”27 This rosy interpretation is pure mythology.

Keynes’s significant role in planning for reparations dispels any notion that he resigned over reparations. He recommended imposing a large upfront payment on the Germans; he originated the idea of a long-term indemnity; it was his idea to leave the amount of reparations unfixed in the treaty; and he drafted Article 231. Keynes did not oppose the reparations settlement; he was its chief architect.

More fundamentally, those who assert that Keynes resigned out of concern for Germany seriously misconstrue the man. He was a die-hard British “nationalist.”28 His overriding concern was to protect and advance the British Empire’s position in the postwar world. It is absurd to argue that Keynes resigned over German problems. Surely, British problems led to his resignation.

So why did Keynes resign? He devised the system of inter-allied war loans, and he understood that his system had passed financial hegemony from Britain to the United States. He wrote in October 1916, “The American executive and the American public will be in a position to dictate to this country.”29 By 1917, President Wilson recognized that Britain was “financially in our hands” and “when the war is over we can force them to our way of thinking.”30 Keynes acknowledged that Britain was in the “financial grip of the U.S.” just before the conference:   

The sum we ourselves owe to the United States must undoubtedly be regarded as very real debts. … Such a burden will cripple our foreign development in other parts of the world, and will lay us open to future pressure by the United States of a most objectionable description.31

Keynes went to the Paris Peace Conference to reclaim Britain’s financial supremacy from the United States. Of course, this meant the Americans were his great opponents at the conference. As Skidelsky admits, “What has not been sufficiently appreciated is the extent to which Keynes was anti-American. … He wanted to keep America out of Europe”.32 The Paris Peace Conference was just the beginning of Keynes’s failed lifelong crusade to win back Britain’s financial hegemony.

Keynes played the key role in creating Britain’s “difficult and embarrassing” war-debt problem.33 He went to the conference to solve the problem, but he failed. He resigned in protest against American opposition to war-debt cancellation. In other words, Keynes resigned because he could not solve the war-debt problem he had masterminded.

The Consequences of Keynes

The economic consequences of Keynes’s war-debt problem were significant. Britain’s war-debt plagued her after the war and, in the early 1930s, Keynes advised the British government to default.34 The government obliged after 1933. The result was the Johnson Act of 1934, which prohibited the United States from making loans to any country in default.

When the Second World War broke out, the Johnson Act prohibited the United States from assisting Britain with war loans. Consequently, Britain became totally dependent on the Lend-Lease Program, and “During World War II, Keynes, from the British Treasury, spearheaded the United Kingdom’s lend-lease financing.”35 Throughout the war, the United States used the Lend-Lease Program to dismantle the British Empire. Given his central role in the war-debt problem and Lend-Lease, Keynes deserves much credit for the demise of his beloved empire.36

Also, the war-debt problem had significant economic consequences internationally. It was a major factor in the trade and currency wars of the 1920s and 1930s. This economic warfare contributed to the Great Depression of the 1930s, and it played a neglected role in the outbreak of Second World War. Although many of today’s financial problems are traced to the 1930s and 1940s, they have their ultimate origins in the financial pandemonium created by the First War World. And Keynes was at the center of the chaos.

Like the economic consequences, the political consequences of Keynes were disastrous. As Thomas Lamont put it, Keynes “paved the way for Hitler’s rise.”37 Of course, Keynes did not make Hitler inevitable. But he played a significant role in creating the political conditions that made Hitler possible.

German resentment of the Treaty of Versailles was the major cause of Hitler's rise to power. It was Keynes’s idea to not fix the amount of reparations in the treaty. This gave the Germans an unlimited theoretical liability, and they felt condemned to indefinite slave labor. Keynes’s idea of a “blank check” enraged the Germans, and it was a serious source of German opposition to the treaty.

More importantly, Keynes was a lead author of Article 231 of the treaty, and this clause became the focus of German opposition to the treaty. Article 231 was one of Hitler’s most important propaganda weapons during his rise to power. Given his central role in drafting Article 231, Keynes certainly contributed to the rise of Hitler.

The Economic Consequences of the Peace only incited the Germans after the war. In hindsight, his attack on the treaty was fatally flawed. Regardless, The Economic Consequences of the Peace greatly amplified German opposition to the treaty. By stimulating German opposition to the treaty, Keynes helped launch Hitler into power.

The Economic Consequences of the Peace is not Keynes’s one good book, his saving grace. Rather, it must be considered his most tragic book. No doubt, Keynes knew that he helped set the stage for Hitler. In 1933, he admitted his remorse to the German-born Cambridge historian Elizabeth Wiskemann. Keynes regretted The Economic Consequences of the Peace, and so should we.

On the morning after the German election, I travelled to Basle; it was an exquisite liberation to reach Switzerland. It must have been only a little later that I met Maynard Keynes at some gathering in London. I do wish you had not written that book, I found myself saying (meaning The Economic Consequences, which the Germans never ceased to quote) and then longed for the ground to swallow me up. But he said, simply and gently, So do I.38

  • 1. Robert Skidelsky, John Maynard Keynes: Hopes Betrayed (New York: Viking, 1983), p. 384.
  • 2. The Collected Writings of John Maynard Keynes, vol. 2, p. 175.
  • 3. The Collected Writings of John Maynard Keynes, vol. 2, pp. 177–78.
  • 4. The Collected Writings of John Maynard Keynes, vol. 2, p. 172.
  • 5. The Collected Writings of John Maynard Keynes, vol. 16, p. 3.
  • 6. The Collected Writings of John Maynard Keynes, vol. 18, pp. 383–84.
  • 7. Roy Harrod, The Life of John Maynard Keynes (London: Macmillan, 1951), p. 206.
  • 8. “Memorandum on the Treatment of Inter-Allied Debt Arising Out of the War,” The John Maynard Keynes Papers (Cambridge, UK: King’s College, PT/7/11–21), p. 16.
  • 9. In Edward M. House and Charles Seymour, What Really Happened at Paris: The Story of the Peace Conference, 1918–1919 (New York: Charles Scribner’s Sons, 1921), p. 289.
  • 10. In The Collected Writings of John Maynard Keynes, vol. 16, p. 437.
  • 11. The Collected Writings of John Maynard Keynes, vol. 2, pp. 176–77.
  • 12. The Collected Writings of John Maynard Keynes, vol. 2, pp. 172–73.
  • 13. The Collected Writings of John Maynard Keynes, vol. 3, p. 113, vol. 18, pp. 377, 381–82.
  • 14. “Reparation and Indemnity,” The John Maynard Keynes Papers (Cambridge, UK: King’s College, RT/14/31–34). Available at https://mises.org/wire/keynes-and-versailles-treatys-infamous-article-231.
  • 15. The Collected Writings of John Maynard Keynes, vol. 16, pp. 314–34.  
  • 16. David Lloyd George, The Truth about the Peace Treaties (London: Victor Gollancz, 1938), p. 446.
  • 17. The Collected Writings of John Maynard Keynes, vol. 16, pp. 344–83.
  • 18. Charles Hession writes, “when the conference became bogged down on the amount of reparations to be demanded of the defeated nation, it was his suggestion that the exact sum be left undetermined.” John Maynard Keynes (New York: Macmillan, 1984), p. 147. For documentation, see https://mises.org/wire/keynes-and-versailles-treatys-infamous-article-231.
  • 19. Donald Moggridge writes, “The significant draftsman of the clause were Keynes and John Foster Dulles.” Maynard Keynes: An Economist’s Biography (New York: Routledge, 1992), pp. 308, 331, 346. For documentation, see https://mises.org/wire/keynes-and-versailles-treatys-infamous-article-231.
  • 20. The Collected Writings of John Maynard Keynes, vol. 2, p. 166.
  • 21. The Collected Writings of John Maynard Keynes, vol. 16, pp. 379–81.
  • 22. Ibid., p. 382.
  • 23. The Collected Writings of John Maynard Keynes, vol. 3, p. 109.
  • 24. “Speech to the Cambridge Union, 20 January 1903,” The John Maynard Keynes Papers (Cambridge, UK: King’s College, OC/5/4–26), p. 24.
  • 25. Robert Skidelsky, John Maynard Keynes: Economist as Savior (New York: Viking, 1992), p. 311.
  • 26. Ludwig von Mises, Omnipotent Government (1944; repr. Indianapolis: Liberty Fund, 2011), p. 241.
  • 27. Robert Skidelsky, "Commanding Heights," p. 6. Available at https://www.pbs.org/wgbh/commandingheights/shared/pdf/int_robertskidelsky.pdf.
  • 28. Robert A. Mundell, in Bertil Ohlin: A Centennial Celebration (Cambridge, MA: Massachusetts Institute of Technology Press, 2002), p. 259n17; Benjamin Steil, The Battle of Bretton Woods (Princeton: Princeton University Press, 2013), p. 149.
  • 29. The Collected Writings of John Maynard Keynes, vol. 16, 198.
  • 30. Keynes, quoted in Niall Ferguson, The Pity of War (New York: Basic Books, 1999), pp. 327, 329.
  • 31. The Collected Writings of John Maynard Keynes, vol. 16, p. 418.
  • 32. Skidelsky, John Maynard Keynes, p. 20.
  • 33. The Collected Writings of John Maynard Keynes, vol. 16, p. 419.
  • 34. The Collected Writings of John Maynard Keynes, vol. 18, pp. 373–76, 382–86, 387–90.
  • 35. In Harold L. Wattel, The Policy Consequences of John Maynard Keynes (Basingstoke: Macmillan, 1986), p. 117.
  • 36. Benjamin Steil writes, “[the US] would for years use Lend-Lease to press the British relentlessly for financial and trade concessions that would eliminate Britain as an economic and political rival in the postwar landscape.” He continues, “This would necessarily involve dismantling the structural supports of the empire. No Briton read the U.S. Treasury’s intentions better, and resented them more bitterly, than Maynard Keynes.” See Battle of Bretton Woods (Princeton: Princeton University Press, 2013), pp. 108, 110.
  • 37. Ron Chernow, The House of Morgan (New York: Grove Press, 2010), p. 208.
  • 38. Elizabeth Wiskemann, The Europe I Saw (New York: St. Martin’s Press, 1968), p. 53.

Contact Edward W. Fuller

Edward Fuller, MBA, is a graduate of the Leavey School of Business.

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