When Iranian President Mahmoud Ahmadinejad visited the U.S. recently, he didn't say explicitly that the Holocaust was a myth. Instead he asked why so much emphasis is put on the 6 million Jews who died during WWII rather than the 60 million people who perished during the conflict. Then, at a Tehran conference where Holocaust deniers congregated with Orthodox rabbis who apparently believe the state of Israel should not exist, Ahmadinejad offered a message satisfying each camp. He told the delegates that the Holocaust should be questioned and that Israel's days are numbered. 

 

One wonders, with the terrible lessons of 20th century totalitarianism still so ripe, how history could repeat itself so blatantly and so soon. I hold that the answer lies in just how one-party states such as modern Iran emerge, and of what happens when the access to capital is limited within societies.

 

Of course, the systematic extermination of the Jews started in the early 1930s. By then, Germany had rebuilt itself from the ruins of WWI and the devastating hyperinflation of the 1920s into a powerful, educated, industrialized nation, where science and technology thrived. True, all this occurred within a one-party state. Yet, if such apparent prosperity can lead to murderous instincts not being suppressed, where is the advantage of Western Civilization, which is built on the concept of prosperity? In a recent op-ed in the Wall Street Journal, Mark Bowen asked, Why is the Holocaust haunting the collective memory of the West? Bowen concluded, "what the Holocaust demonstrates is the danger of a one-party state."

 

This conclusion is partially correct, but it begs the question: How did Germany get from the Weimar Republic, a democracy, to the one-party state? And why did the Germans tolerate such a state and accept its murderous ideology? Whether the Germans agreed deep down with Hitler & Co. is irrelevant. Actions - or, in this case, the lack of actions - matter.

 

During the 1920s, Germany, Austria, Hungary, Poland, and Russia each printed money with abandon. This brought about hyperinflation, which weakened or destroyed the capital markets in these countries. Banks failed, markets crashed, unemployment rose, and the middle classes lost their lifetime savings.

 

People want to live first and philosophize a bit later. With their savings gone, these Europeans turned to two other ways of accessing capital: government and crime. Predictably, each of these countries moved toward centralization - that is, government become the main financial intermediary.

 

When the citizens of these countries looked abroad, there was little to admire. England and the U.S. were each suffering through depressions (in the U.S., due to mistaken fiscal and monetary policies). These governments too moved toward centralization, though to a much different degree. Up sprung the jargon of "public works" and, eventually, the Keynesian term "aggregate demand." Here the governments also would become intermediaries, charged with raising and then allocating capital. Importantly, however, this was done without England or the U.S. ever becoming one-party states.

 

Power is dispersed within democracies, and democracies are always weakened when more money flows through government hands. This is true even when the facade of democracy persists. When more capital sifts through the government, more groups depend on government handouts and have less access to sources of capital that are independent from the ruling political parties. But the U.K. and the U.S. retained many more independent sources of capital than did Germany, Austria, Hungary, or Russia during the 1930s.

 

The dangers come when a country either does not develop its capital markets or destroys them on purpose or inadvertently. When this is the case, the chances of one party taking power and imposing its ideology increase.

 

Conversely, when capital markets are opened, the risk that one-party states will emerge diminishes. As independent sources of capital surface, political power is dispersed and lasting prosperity follows. Thus, it is a mistake to promote democracy without first establishing the ground for letting people have access to capital and collateral - or at least coordinating such access with political change. After all, prosperity is the result of matching people with capital, while holding both sides accountable.

 

What happens when societies either do not have or destroy their financial markets? Even today very few societies have developed the institutions that can enable the development of deep financial markets - a solid legal infrastructure and free media among them. In this scenario, most people wanting access to capital have no other option but to turn to government, which will raise the money - either through taxes or borrowing - and then distribute it.

 

That's how one-party states such as Ahmadinejad's Iran emerge: People bet on crazy ideologies when their customary ways of living suddenly crumble and capital markets close. Capital markets are the unique feature of the West, and their democratization is the key to the civilizing process and the best insurance against the emergence of one-party states. Indeed, that's what the U.S. should have been "exporting" all along in the Middle East, coordinating the promotion of capital markets with the necessary political changes in Iraq.

 

— Reuven Brenner holds the Repap chair at Desautels' Faculty of Management, and is partner in Match Strategic Partners. The article draws on his books Force of Finance (2002) and History: The Human Gamble (1983).