In the winter of 1978, diamond dealers in New York City were becoming increasingly concerned about the possibility of a serious rupture, or even collapse, of the pipeline through which De Beers' diamonds flowed from the cutting centers in Europe to the main retail markets in America and Japan. This pipeline, as every dealer knows, is a crucial component in the diamond invention made up of a network of brokers, diamond cutters, bankers, distributors, jewelry manufacturers, wholesalers and diamond buyers for retail establishments. Most of the people in this pipeline are Jewish, and virtually all are closely connected through family ties or longstanding business relationships. New York City's diamond district, where nearly half of all the gem diamonds in the world are bought or sold, is a key juncture in the pipeline.

The diamond district is located mainly in a single block on 47th Street between Fifth and Sixth Avenues. If one walks along the street level, he sees mainly retail stores with such enticing advertisements as, "We Buy Retail; Sell Wholesale." These stores are meant mainly for tourists. The real diamond exchange, involving the sale of billions of dollars worth of loose diamonds, takes place in "clubs" and offices discreetly located on the upper floors of these buildings. Most of the smaller dealers are members of the Diamond Dealers Club, at 30 West 47th Street. Although the name evokes images of a plush and luxurious meeting place, the Diamond Dealers Club more closely resembles a tawdry cafeteria, with its linoleum floor and rows of bare tables. The 2,000-odd members, many of whom are Hasidic Jews, sit across the tables from one another like players at a chess tournament, their gaze fixed on an assemblage of tiny diamonds spread out on a piece of paper in between them. Every few moments a diamond sale is made, the diamonds on the table are sealed in the paper. In the center of the room there is a glass booth where diamonds are officially weighed after the transaction is agreed upon. Meanwhile, a loudspeaker system pages members to the telephone where they conduct further business. (Most of the members have no other office than the "club.") The club also provides a room for the afternoon prayer and a kosher restaurant.

The larger dealers do their business not in the trading hall of the diamond club but in their own well-protected offices. Almost all these offices have closed-circuit television cameras to identify visitors, and at least three sets of locked doors through which the visitor must pass. The rule in the diamond district is that no stranger is ever admitted to these private offices. Since dealers commonly carry on their persons millions of dollars worth of diamonds, such stringent precautions are an indispensable part of the profession. The New York dealers are dependent on the flow of diamonds from London to the diamond-cutting factories in Tel Aviv. In the nineteen-seventies, however, a crimp emerged in the pipeline when Israeli diamond dealers, rather than processing and passing the diamonds on to New York, stockpiled them. Since diamond prices were then rapidly increasing at the time, and Israeli currency depreciating by more than 50 percent a year, it became more profitable for Israeli dealers to retain the diamonds that they received from London than to cut and sell them for paper money. These Israeli dealers, moreover, could borrow money from the banks on their diamonds at relatively low interest rates. As more and more diamonds were taken out of circulation at the Tel Aviv end of the pipeline, an acute shortage began in New York, driving prices up. By 1979, these Israeli stockpiles began indeed to threaten the entire diamond invention.

Until the Second World War, the diamond invention rested on three legs: production, centered in Africa; distribution, based in London; and diamond cutting, located almost exclusively in Antwerp. The German invasion of Belgium, however, knocked out one of the legs of the tripod-Antwerp. Oppenheimer had provided the Belgian cutting factories there with the lion's share of De Beers diamonds, and he could count on them not to resell the diamonds to speculators or other "weak hands." But with the fall of Antwerp, the diamond-cutting industry left De Beers' universe of control.

Since many of the cutters in Antwerp were Jewish, the British-mandated territory of Palestine (Israel) became a natural focal point for the displaced industry. The birth of this new Israeli industry began in 1939 when two Jewish refugees in tattered clothes arrived at the port of Haifa in Palestine. When the customs officer on duty searched through their meager personal belongings, he discovered an envelope containing what looked like hundreds of tiny bits of broken milk glass. He puzzled over them for a moment, and then questioned the refugees about these odd fragments.

The refugees nervously explained that they were both diamond cutters from Antwerp, and the objects in the envelope were, in fact, rough diamonds which they hoped to cut and polish in Palestine. To do this, they told the customs officer they would need a small loan to set up a rudimentary work shop. Did the officer know anyone who might help them, they asked.

The customs officer had never before seen an uncut diamond; indeed, few people in Palestine in 1939 had ever seen one. He therefore took the packet of diamonds to Oved Ben Ami, the mayor of neighboring Natanya. Ben Ami, a short, sprightly man in his early thirties, was one of the most enterprising of the Jewish pioneers in Palestine. A decade earlier, Natanya was nothing but a marsh between Tel Aviv and Haifa, but Ben Ami, fearing that the Arabs might settle there and drive a wedge between the two Jewish cities, decided to found a Jewish settlement there. He put all his energy into raising money and recruiting settlers, and by 1939 he had succeeded in building a small city. It had, however, no industry. On seeing the diamonds, Ben Ami became interested in the possibility of establishing a diamond industry in his town of Natanya, and he asked to see the refugees.

The two men explained to Ben Ann that very little capital was necessary for cutting and polishing diamonds. All that was needed, in fact, was good sunlight, skilled labor, a few rudimentary tools and a supply of rough diamonds. They even demonstrated how a rough diamond was first cleaved, then cut and polished.

Ben Ami was impressed. He provided the men with a building in Natanya for their work and reached into his own pocket and lent them money for their personal expenses. He then did some further research into the diamond business.

Three requisites, sunlight, labor and tools, would be readily available in Palestine; the problem would be acquiring a steady supply of rough diamonds. He consulted a knowledgeable banker in Tel Aviv, and he found out that De Beers controlled virtually the entire world's supply of diamonds. Since the cartel had an agreement with the government of Belgium, which specified that most of the diamonds would be sent to Antwerp to be cut by Belgian labor, this banker advised him that there was little possibility that the cartel would ever allow Palestine to compete with Belgium.

Although discouraged, Ben Ami refused to give up. He had determined that most of the world's diamond business, including the De Beers cartel, was, as he put it, "in Jewish hands," and he persuaded himself that most of these Jews would be sympathetic to the idea of creating a diamond industry in Palestine. He also realized that the Nazi armies were on the verge of overrunning Belgium and the Netherlands, and that many of the Jewish cutters, like the two refugees, might seek refuge in Palestine. He therefore dashed off a series of letters to the mayors of Antwerp and Amsterdam, as well as a number of guild officials in those cities, suggesting that they consider sending their Jewish cutters to Natanya for the duration of the war. He received, however, no reply until mid- 1940.

Ben Ami finally received a letter from a Jewish industrialist in Antwerp. The industrialist, who had obtained Ben Ami's address from the mayor of Antwerp, offered to pay for the relocation of sixty Belgian diamond cutters in Palestine, Ben Ami could arrange the necessary entrance visas.

Since the British authorities had placed strict restrictions on the number of Jews allowed to enter Palestine, Ben Ami's first task was to persuade the British to waive these quotas on immigrants. He asked Ben-Gurion, then head of the Jewish Agency, for help. Ben-Gurion's first priority was saving Jews from the nations that had already been overrun by the Germans, and not from neutral countries such as Belgium.

Ben Ami went to the British high commissioner for Palestine. In presenting his case, he argued that since most of the diamonds in the world came from the British Empire, it was in the national interest of Great Britain to make sure that the skilled diamond cutters in Europe were not all captured by the Germans. As there was a distinct possibility that Germany would invade Belgium and Holland in the months ahead, he proposed that the British facilitate the immediate transfer of sixty diamond cutters to Palestine.

After studying the memorandum that Ben Ami had prepared on the subject, the high commissioner agreed that some precautions should be taken to protect the diamond trade. Cutting the tangle of red tape surrounding Jewish immigration to Palestine, he issued Ben Ami sixty visas for Belgian cutters.

The next problem for Ben Ami was persuading De Beers to send a supply of diamonds to Palestine. In London, he consulted Harry Abrams, the managing director of De Beers' Diamond Trading Corporation. Ben Ami made the case that De Beers was about to lose its cutting centers in Antwerp and Amsterdam and it should look to Palestine as an alternative. Abrams coldly replied, "Don't worry about us, Mr. Ben Ami. We have enough cut diamonds in our vault to last through the war ... and then some." Moreover, Abrams explained that De Beers had a binding agreement with the Belgian Government that prevented De Beers from sending diamonds to be cut anywhere else. Diamonds for Palestine were simply "out of the question."

Ben Ami was not so easily put off. He sought out the assistance of Otto Oppenheimer, the brother of Sir Ernest, and appealed to him as a Jew to assist not merely the diamond industry but Palestine. Although Oppenheimer thought Ben Ami presumptuous, he finally wearily gave in and told Ben Ami, "I will be your ambassador and try to persuade De Beers."

In fact, Oppenheimer was concerned that Ben Ami was stirring up the Colonial Office about the possible disruption of the diamond trade, and if he persisted, the British government might begin to scrutinize more closely the flow of diamonds around the world. To get rid of this persistent nuisance, Oppenheimer decided with Abrams to provide Ben Ami temporarily with a modest supply of diamonds that could be cut in Palestine.

Ben Ami then flew to Antwerp to recruit the sixty cutters. Even though war with Germany seemed imminent, he found it impossible to persuade the Jewish cutters to go to Palestine. They believed that the Germans, led by General Rommel, were on the verge of capturing Palestine, and they had no intention of leaving neutral Belgium. They were living in "a paradise of fools," he concluded, and in the end, he managed to recruit only a half dozen cutters.

Ben Ami returned to Natanya considering his mission a failure. He had neither the master cutters nor the amount of diamonds he had hoped to obtain. However, within a week of his return, the Nazi armies blitzkrieged their way through the Low Countries. The British dispatched a destroyer to Antwerp in an attempt to seize the cutters' stocks of diamonds before they fell into German hands, and a few of the Jewish cutters escaped with the British raiding party. But the cutting centers of Antwerp and Amsterdam were lost to the Allies-and De Beers-and Palestine now became an expedient alternative

In early 1941, Ben Ami received a message from George Prins, the broker who represented De Beers, saying that a consignment of diamonds had been allotted to Palestine. Before Ben Ami could receive them, however, he would have to pay ten thousand pounds sterling, which was the value De Beers established for them. Even though this was an enormous sum of money in Palestine in 1941, Ben Ami managed to convince a leading bank to advance it to him for the diamonds, which would serve as collateral. When the diamonds finally arrived in a small cardboard box, Ben Ami distributed them to the few trained diamond cutters. The diamonds themselves were relatively small stones, all less than a carat in weight, even in their uncut state. These melees, or medium-grade diamonds, required an enormous amount of labor to cut and finish, and had never been highly profitable goods in Antwerp or Amsterdam.

With a flow of Jewish refugees from Europe, Palestine had, however, an abundance of cheap labor. The diamond-cutting factories in Israel were organized along very different lines than those in Antwerp. Instead of assigning the task of cutting and polishing a. diamond to a single master craftsman, it was divided among six men. This division of labor, called the "chain of six," made it far easier to train and employ diamond cutters and shortened the time involved in finishing the diamonds. Even though the process resulted in slightly inferior workmanship, the difference, especially on the medium-grade diamonds, was not noticeable to the naked eye.

By the end of the war, Palestine had suddenly become the world's largest manufacturing center for diamonds, in terms of quantity, if not quality. During the war years, no less than 5,000 refugees had been trained as cutters, and De Beers had shipped more than $100 million worth of diamonds to Palestine. The rise of this Palestinian industry caused considerable concern in the more traditional cutting centers in Belgium.

After consulting the leading bankers and politicians in Belgium, De Beers decided that the only prudent policy for the cartel was to reestablish Antwerp as the world's manufacturing center. Antwerp was, after all, less than an hour's flight from London, and the dealers there had a long history of collaboration with the cartel. And Belgian interests still controlled the important mines in the Congo. Between 1945 and 1948, De Beers reduced the number of diamonds consigned to Palestine by as much as 70 percent. Moreover, the diamonds it continued to supply were smaller and of inferior quality to the medium-grade diamonds Palestine factories had received during the war. These sharp cutbacks had the intended effect of choking off the nascent industry.

In 1948, however, the Jewish state of Israel was established in Palestine. The new nation had only one viable industry-diamond manufacturing; and both the government and the Israeli banks decided that, despite the shortage of diamonds, that industry had to be aggressively supported. The major banks therefore extended virtually unlimited credit to diamond dealers to buy diamonds from the Belgian clients of De Beers. Since the Belgians preferred to manufacture the larger and more profitable stones, they were quite willing to make an instant profit on the smaller and less profitable stones in their consignments. The Israeli manufacturers made up for the higher prices that they paid for the diamonds by using cheaper labor. By the mid-1950s, Israeli manufacturers again dominated the melee, or small diamond, business-even though they had to buy most of their rough goods on the secondary market. The cartel quickly adjusted to the reality of the situation. Since Israeli manufacturers were determined to get diamonds by one means or another, De Beers decided that it, rather than the Belgian manufacturers, should realize the profits on the Israeli transactions. In an abrupt reversal of policy, De Beers began to supply a number of carefully chosen dealers in Israel with an abundance of melee diamonds. One dealer, Joseph Goldfinger, the cartel's favored instrument in Israel, would be sent more than a hundred million dollars worth of small diamonds a year. De Beers also created its own subsidiary in Israel, Diamondel, to deal in rough diamonds. By 1965, Israel was receiving more than five-sixths of De Beers' total allotment of melee diamonds.

In the 1970s, repeated devaluations of Israel's currency gave the Israeli diamond-cutting industry a competitive edge over its rivals in Antwerp and New York. Not only were the Israeli factories more efficiently organized to cut small diamonds but because of their devalued money, they also had vastly lower labor costs than the factories elsewhere. Not satisfied with dominating the melee diamond business, Israeli dealers began to bid for the larger stones. By 1975, diamonds accounted for nearly 40 percent of Israel's nonagricultural exports, and nearly 20,000 workers were employed in the cutting factories. In Antwerp, by contrast, over one-fourth of all the diamond cutters were out of work, and hundreds of factories, unable to cope with the Israeli competition, faced bankruptcy.

De Beers became seriously concerned that the Israeli competition could disrupt the entire diamond trade. In early 1977, Sir Philip Oppenheimer dispatched his son Anthony to Tel Aviv, accompanied by other De Beers executives. Anthony Oppenheimer's mission was to persuade the Israelis to curtail their expansion. He met with De Beers' favored clients, the bankers who were extending credit to diamond dealers and the government officials who supposedly regulated the Israeli industry. He subtly warned them all that De Beers would not tolerate unbridled competition between Israel and Antwerp, and announced that De Beers intended to cut the Israeli quota of diamonds by at least 20 percent in the coming year.

This warning had the opposite effect of what had been intended. Rather than paring down production in line with this quota, Israeli manufacturers and dealers began building up their own stockpile of diamonds. They paid a premium of one hundred percent or more for the unopened boxes of diamonds that De Beers had shipped to Belgian and American dealers. (And by selling their diamonds to the Israelis, the De Beers clients could instantly double their money without taking any risks.) Israeli buyers also moved into Africa and began buying directly from smugglers. The Intercontinental Hotel in Liberia, which was then the center for the sale of smuggled goods, became a sort of extension of the Israeli bourse. After the Israeli dealers had purchased the diamonds, either from De Beers' clients or smugglers, they received 80 percent of the amount they paid from Israeli banks in the form of a loan. Because of government pressure to help the diamond industry, the banks charged only 6 percent interest on these loans, well below the rate of inflation in Israel. By 1978, the banks had extended $850 million in credit to diamond dealers, an amount equal to some 15 percent of the entire gross national product of Israel. The only collateral the banks had for these loans were uncut diamonds.

De Beers estimated the Israeli stockpile to be more than 6 million carats in 1977 and growing at a rate of almost a half million carats a month. At that rate, it would be only a matter of months before the Israeli stockpile would exceed that of the cartel's in London. If Israel controlled such an enormous quantity of diamonds, the cartel could no longer fix the price of diamonds with impunity. At any time the Israelis could pour these diamonds onto the world market, destroying forever the carefully nurtured mystique of the value of diamonds. The cartel decided that they had no alternative but to force liquidation of the Israeli stockpile.

By 1977, however, the situation in Israel was almost completely out of De Beers' control. The Goldfinger organization, and other of De Beers' leading distributors in Israel, told De Beers that even if they cut back on their purchases, independent dealers and speculators would step in to take up the slack. The distributors warned the cartel that as long as the banks were willing to finance diamond purchases with artificially low interest rates, there would be no effective way of stopping Israelis from accumulating diamonds as a hedge against inflation. If it wanted to bring the diamond speculation under control, De Beers would have to clamp down on the banks.

De Beers was not without influence in Israeli banking circles. Harry Oppenheimer sat on the board of directors of Barclays International Bank, which controlled Barclays Discount Bank in Israel. And E. J. G. Dawes, one of the managing directors of the De Beers operation in London, was on the board of directors of the Union Bank of Israel, which together with Barclays Discount Bank financed more than half of all the Israeli diamond purchases. De Beers made it clear to the Israeli bankers that it considered the present speculation to be extremely dangerous. Moreover, it warned that it was adopting a new strategy of imposing "surcharges" on diamonds, which might be abruptly withdrawn at any moment. Since these "surcharges," which would range as high as 40 percent of the value of the diamonds, were effectively a temporary price increase, they could be extremely risky to banks extending credit to diamond dealers. For example, with a 40 percent surcharge, a diamond dealer had to pay $1,400 rather than $1,000 for a small lot of diamonds; however, if the surcharge was then withdrawn, the diamonds would be worth only a thousand dollars. Through this device, De Beers, in effect, announced that it was embarking on a policy of manipulating the prices of diamonds in order to trap speculators. Under these circumstances, the Israeli banks could not afford to advance 80 percent of the purchase price, including the so-called surcharge. They therefore required additional collateral from the dealers and speculators. Further, they began, under pressure from De Beers, to raise interest rates on outstanding loans.

Within a matter of weeks in 1977, interest rates on diamonds went up 50th percent. Moreover, instead of lending money based on what Israeli dealers paid for diamonds, the banks now would only lend money based on the official De Beers price for diamonds. If a dealer paid more than the De Beers price for diamonds-and most Israeli dealers were paying at least double the price in 1977-he would have to finance the increment from his personal funds.

To tighten the squeeze on Israel, De Beers abruptly cut off shipments of diamonds to forty of its clients who had been selling large portions of their consignments to Israeli dealers. This dramatic reprisal made De Beers' 250 or so remaining clients aware of the risks involved in trafficking with Israel.

As Israeli dealers found it increasingly difficult either to buy or finance diamonds, they were forced to sell diamonds from the stockpiles that they had accumulated. As Israeli diamonds poured onto the market in 1979, prices began to fall at the wholesale level. This decline led the Israeli banks to put further pressure on dealers to liquidate their stocks to repay their loans. Speculators found themselves caught between rising financing charges and lower prices, and in a state approaching panic, began selling their diamonds regardless of the price they had paid. Hundreds of Israeli dealers, unable to meet their commitments, went bankrupt in the fall of 1980 as prices continued to plunge. The banks inherited the diamonds. De Beers had won the first round in the diamond war with Israel.