Dwarves are a staple of tabletop fantasy role-playing games (RPGs) since the beginning in the 1970s, adapted from Tolkien's works. However, many are unaware of the origins of the dwarven stereotypes that Tolkien wrestled with.
Tolkien was explicit in letters and interviews that he intended dwarves to be akin to Jewish people. As a linguist, he based the dwarven language Khuzdul on Semitic languages -- primarily Hebrew, featuring triconsonantal roots and similarities to Hebrew's phonology and morphology. In a letter to Naomi Mitchison in December 1955, he wrote regarding broadcast adaptations of his work:
I thought that the Dwarf (Glóin not Gimli, but I suppose Gimli will look like his father – apparently someone's idea of a German) was not too bad, if a bit exaggerated. I do think of the 'Dwarves' like Jews: at once native and alien in their habitations, speaking the languages of the country, but with an accent due to their own private tongue.....
And in a 1960 radio interview he elaborated:
The dwarves, of course, are quite obviously, couldn't you say that in many ways they remind you of the Jews? Their words are Semitic obviously, constructed to be Semitic. There's a tremendous love of the artifact, and of course the immense warlike capacity of the Jews, which we tend to forget nowadays.
This association did not come out of nowhere, however. Rather, I would argue that Tolkien wanted to reinvent dwarves as compared to the dwarf villains of Wagner.
Much of the Lord of the Rings has roots in Norse myth. However, the specific mythic elements were popularized by Richard Wagner's series of four operas known as the Ring Cycle, written from 1848 to 1874. The cycle's plot revolves around a magic ring that grants the power to rule the world, forged by the Nibelung dwarf Alberich from gold he stole from the Rhine maidens in the river Rhine. Obviously, magic rings, dwarves, and dragons were also central to Tolkien.
Wagner was virulently anti-Semitic, as made clear in his 1850 essay “On Jewishness in Music” and many other expressions. As the villain of the series, the dwarf Alberich embodies greed, pettiness, and lovelessness that Wagner associated with Jews. Wagner may not have intended Alberich to be an anti-Semitic allegory, but for decades productions frequently personified him as such. Wagner's works experienced a great boost in popularity under the Nazis, during the same period as Tolkien was developing his Middle Earth.
Tolkien made clear his hatred of the Nazis multiple times in his letters. In 1938, The Hobbit was considered for translation into German, and the publishers asked if Tolkien was "Aryan" as a prerequisite to publication. In his draft response, Tolkien wrote:
But if I am to understand that you are enquiring whether I am of Jewish origin, I can only reply that I regret that I appear to have no ancestors of that gifted people.
As it turned out, The Hobbit wouldn't be translated into German until 1957, nearly twenty years later.
In this light, Tolkien's dwarves can be seen as a rejection of Wagner's anti-Semitism. They are intentionally a heroic and generally positive force in his stories, rejecting Wagner's use of them as villains.
That said, Tolkien's dwarves still have many negative flaws like their greed that Thorin fell prey to. Nevertheless, it is important to understand that Tolkien was intentionally making major progress over Wagner - creating a progressive reinvention of dwarves and attitude towards Jewishness.
Tolkien intended his dwarves to be like Jewish people, but in later adaptations they shifted to be more of a Scottish stereotype, pitched as hard-working, beer-drinking Scottish miners. This particularly came through in Peter Jackson's films, but had already been an association before then.
Substituting a Scottish association isn't ...