Financial chapters of the war

Preface

The purpose of this book is to describe clearly, and explain without technicality, the remarkable financial and economic episodes which have attended the European War. The general public understood perfectly, from the very first days of the conflict, that its economic results were certain to be as momentous as its political results. But the most experienced financiers were at loss to say beforehand what the financial character of the war would be. When it began, they found it equally impossible to measure the real significance of the first economic occurrences. It is hardly surprising, therefore, that the general public shoiild have been unable to understand what had actually happened. Financial events were in fact so extraordinary and complicated as to leave the mind of many readers of the news in complete bewilderment.

It is my hope that these chapters may serve to clear up that perplexity. Perhaps no questions have been asked more frequently since July, 19 14, than the questions how the fighting nations have been able to raise the $100,000,000 per day which vi PREFACE

they are spending on war ; why the seemingly convincing prophecy of the shortening of war because of economic exhaustion has not been fulfilled; what was the meaning of that "depreciation in the foreign exchanges" of which we have heard so much; whether Europe has lapsed into irredeemable paper currency like that of our Civil War; by what means the United States — ^largely dependent on Europe, in a financial way, before the war — should so suddenly have acquired the power of paying off its foreign indebtedness, financing neutral nations from its own resources, and lending even to belligerent Europe larger sums than Europe itself had raised for its earlier wars. Along with these considerations came the further inquiries : Is this American war-time prosperity -unreal, temporary, and fictitious ? Will the conditions of 191 5 and 1916 be instantly reversed when war is over ? Has New York actually displaced London as the financial centre of the world ? On these questions I shall endeavor to throw some light.

It would be presumptuous for any one to claim ability to answer all of them. One reason why this book bears its present title, instead of being described as a financial history of the war, is that the actual and relative importance of many economic phenomena of the period cannot be determined conclusively until the war itself is over.

PREFACE vu

But it is possible at least to give to the general public the means of understanding exactly what has happened already. Every reader of history will agree with me that the lack of clear contemporaneous exposition of the financial events of our own war from 1861 to 1865, or, even more particularly, of the great Napoleonic wars, is one of the greatest obstacles to the full historical comprehension of those episodes.

I have drawn freely in this book on my previous discussion of the same subjects in Scribner's Magazine, and have also utilized an article written by me last autumn in the Yale Review. But with the recent rapid movement of events, economic as well as military and political, it will readily be understood that all previous comment had to be rewritten, and that the greater part of this book should be made up of previously unpublished matter.

A. D. N.

New York, September, 1916.

Contents

CHAPTER

PAGE

I. Precedent and Prediction . . i

Chapter I

BEFORE the European War broke out, the most familiar answer of the banking community, to predictions of such a war, was that the economic consequences would be so terrific as to deter any statesman or ruler from committing his country to them. After the fighting had begun, prediction was quite as general to the effect that the war must necessarily be short, because none of the belligerents would be able to endure the financial strain. In concrete terms, this forecast usually shaped itself in the statement that economic exhaustion could not fail to reach, by the end of 191 5 at any rate, so acute a stage as to compel the ending of hostilities.

Both predictions we now know to have been entirely wrong, and they were not more promptly and completely refuted by the course of events than were the prophecies of specific phenomena, military or financial. These facts cannot well be ignored in attempts to forecast the still weightier problems which will arise on return of peace. Prediction of those later results, whether based on experience of history or on particular circumstances of the day, has no greater presiunption of inf allibiHty than the predictions of immediate results in 1 9 14. Certainly no more baffling and bewildering question has been presented for a century past, in the field of political and economic history, than the question what is to be the aftermath of the present war. Politically, problems are involved of so complicated a nature that the forecast even of the most experienced European statesman could not be better than a guess. As a matter of fact, statesmen have risked no such predictions, but have restricted themselves to general expressions of their hope or purpose, such as "the insuring of permanent peace in Europe" or "the ending of the burden of militarism." As to precisely what measures would or could insure these wished-for consummations, on any supposition regarding the military outcome of the war, the public men were silent. The post-bellum territorial readjustment, post-bellum conditions in the internal politics of the states now indulging in so imparalleled sacrifice of blood and treasure, were sure to be powerful factors in determining the future; yet even as to these, we had only such vaguely formulated suggestions as the "realizing of Russia's aspirations in the Bosporus," the "creation of an autonomous Poland," or the "recovery by France of her lost provinces."

THE FORCES AT WORK 3

As with the political sequel to the war, so with its financial and economic sequel. In both directions forces of incalculable magnitude had been set loose in this epoch-making conflict, and their effect on the political and economic structure of Europe was rendered more utterly novel a problem by the extremely complicated character which international relations of every sort have assumed in the past generation. When the aggregate daily military expenditure of the belligerent powers had become ten times as great as in any previous war of history ; when the European states, already bitrdened with the accumulated public indebtedness of the past half-century, doubled or trebled that debt within two years; when the mere annual interest charge on the new indebtedness may presently exceed the total yearly public revenue of the several belligerent states in the year before the war, it is scarcely surprising that the financial community itself should have listened to any theory promulgated as to conditions after the war. Even in the plans and discussions of practical business men, this unknown future gradually assumed the aspect of something terrible because it was unknown. The formula of Preparedness, which very soon occupied a front place in legislative controversy, with neutral states even more than with belligerents, embodied the popular conception, not of conditions which must in the nature of things arise when the war is over, but of conditions which the imagination pictured as possibilities. Seeing that high experts either disagreed diametrically in their predictions, or else confessed their inability to predict at all, it was perfectly natural that imagination should have drawn some startling pictures, yet that the pictures should have differed absolutely from one another.

Financial as well as political observers had, it is true, the voluminous history of the world's great wars on which to base conclusions. Among other precedents, the financial sequel to the outbreak of our own Civil War was not without possible suggestions. Delegates from the seceding States had, on February 8, 1861, met at Montgomery and formed the Southern Confederacy. It was not, however, until after Lincoln's inauguration on March 4, when the certainty of war began to be recognized, that the banking crisis actually developed. In April banks at all the Northern cities temporarily deferred cash payments; in May the Southern banks suspended specie payments altogether, and the new Confederate Government officially forbade payment of debts by Southern to Northern houses. The Northern dry-goods trade fell into panic; merchants' paper being discounted at the banks for as high a rate

WHEN OUR CIVIL WAR BEGAN 5

as 3 per cent a month. Yet the crisis seemed to have been overcome until the gold of the country began to be rapidly drained away on export in the autumn. On December 17 the New York banks concurred in a formal resolution that the situation gave "no reason, justification, or necessity for a suspension of specie payments"; but less than a fortnight later they took precisely that action, and the country was soon committed to the irredeemable government paper currency, for which redemption in coin was not provided until seventeen years later, more than thirteen years after the ending of the war.

One or two of these incidents had a bearing on the possible course of economic events in the European War, and we shall find some interesting analogy ia the manner in which, contrary to all prediction of financial markets, the enormous war loans of our Civil War were floated. But with those points of very general resemblance, the economic parallel ends. The war of 1861 was a purely domestic struggle; the commerce of the United States was imimpeded; we raised money freely by the sale of our new securities to the outside world. No real analogy with the circimistances under which this present war broke out could in fact be found, short of the Napoleonic conflict of a century ago. Twelve nations were simultaneously at war in 181 5; twelve were at war exactly a hundred years later; nothing approaching a contest with such scope had occurred in the intervening period. In none of the wars since Waterloo had campaigns been simultaneously fought by European colonists on other continents, and in remote parts of the world. In none of them had sea fights on the coast of South America or Australia divided interest with battles in the centre of Europe.

At the very beginning of the present war was duplicated that episode which has so often seemed incredible, and which even the historians describe as a "barbarous decree" — Napoleon's seizure and imprisonment, for a dozen years after his declaration of war in 1803, of 10,000 English tourists and residents in France. The struggle of the small neutral states of Europe, after 1805, between the upper and nether millstone of the powerful belligerents reads like a chapter from last year's history of southeastern Europe. Nelson's bombardment of Copenhagen and its fleet in 1809, at an hour when Denmark was not at war with either side, but merely balancing between alliance with the English or the French, can nowadays be better understood by those who have watched the recent predicament of Greece.

For a hundred years, readers of history have looked back with astonishment to the 10 per cent tax levied on English incomes at the opening of

ANALOGIES OF HISTORY 7

the nineteenth century. To-day incomes of English citizens pay 25 per cent and upward to the government. "Pitt's subsidies" have reappeared on an immensely expanded scale in the $1,500,- 000,000 advanced for war purposes by England to her allies in a single twelvemonth. Since July, 1 9 14, the world has again, for the first time in more than a hundred years, seen captured cities in the heart of Europe deliberately given to the flames, citizens held for hostage, tribute imposed on non-resisting towns occupied by the enemy — occurrences which were supposed, with the civilized world's formal adoption of a humane code of international relations, to have been relegated to the limbo of other centuries. Even the chapter in the story of Napoleonic Paris at which later generations have smiled — the hysterical outcry over the "English lies" to which was ascribed unpleasant news about the war — has been reproduced to an admiring world by twentieth-century Berlin.

In no respect was the parallel more startling than in the great collision over the rights of neutral ships, which repeated, step by step, the story of the "Orders in Council," the "Berlin Decree," and the "paper blockades" of the Napoleonic conflict. During the whole of 191 5 the greatest of the neutral Powers lived over again, with remorseless coincidence of causes and yet with the most impressive contrast of circumstance, the long series of episodes which led up to our War of 1812; the historical parallel lying not only in the fact of two European antagonists, in the earlier period, interfering with our commerce in order to injiire one another, but in the further fact that both of them on that occasion, like one of them in the present instance, conditioned their own suspension of unlawful attacks upon our vessels on our government's inducing the other belligerent to stop blockading its European enemy — a proposal of which President Madison, anticipating President Wilson's attitude, bitterly remarked to Congress that it was tantamount to "asserting an obligation on a neutral Power to require one belligerent to encourage by its internal regulations the trade of another belligerent." With political, military, and financial events repeating with such dramatic accuracy the story of the Napoleonic wars, it might surely have been assumed that even the economic history of the present war, during the period of hostilities and afterward, might have been foretold from the records of a century ago.

One reason, recognized from the very start, why this process of analogy was boimd to fail, lay in the prodigious cost of war to-day. As to what that cost would be, political statisticians and military experts had for years been busy estimat-

THE COST OF MODERN WAR 9

ing. Out own War of Secession cost the United States Government $1,000,000 per day in its early stages and $3,000,000 daily during and after 1863. An official French report of January, 187 1, reckoned the current daily expenditure of France for the war with Prussia at $3,200,000. The little Transvaal War, lasting from October, 1899, to June, 1902, cost England $1,085,000,000, or a million dollars a day. Japan and Russia spent between them $3,500,000 daily on the Manchurian War of 1904. When the question of a possible "general war" came into anxious controversy in the last-named year, a well-known French statistician, M. Jules Roche, calculated that in a conflict involving two or three great Powers the average daily cost for all combined would be about $6,000,000, but that a war in which France, Russia, Germany, and Austria were all engaged would cause a total average expenditure, for purely military purposes, of $18,000,000 per day. The somewhat earlier estimate of an Austrian economist had figured that participation in a European war would cost France $5,100,000 per day, Russia $5,600,000, Germany $5,000,000, and Austria $2,600,000. In 1913, when the Balkan War once more revived speculation as to the possibilities of a general conflict. Doctor Charles Richet, of the University of Paris, on the basis of a very elaborate calculation, estimated that if lo PRECEDENT AND PREDICTION

Germany, England, France, Russia, Italy, Austria, and Rumania were all to engage in war, the actual average expense of the campaign per day would be $54,100,000. This estimate, it will be observed, came very close to naming the actual belligerents of 19 14. Even when republished at the outbreak of the present war, the figure was commonly regarded as incredible. Yet exactly a year after hostilities had begim, the German imperial chancellor told the Reichstag that the daily cost, to all the Powers involved, was $75,000,000. The daily expenditure of England and Germany alone in the middle of the present year was greater than Doctor Richet's estimated outlay for all seven belligerent Powers, and the estimate of international bankers in June, 19 16, as to the total daily outlay by all the European belligerents combined, was $103,000,000.

Now, the average daily cost to England of the entire Napoleonic War was less than $2,000,000, as against the $25,000,000 average which it has reached this present year. It is true that the national wealth has increased at an almost equal rate. But, on the other hand, when Pitt placed his 10 per cent tax on English incomes in that earlier period there had been no income tax at all in England, whereas English incomes, early in 19 14, were already paying what was traditionally called a "war rate" of taxation. The cost of war

IN THE DAYS OF NAPOLEON ii

to Napoleon was trifling compared with the expenditure of continental belligerents to-day. It was possible for him to tell the Directory at Paris that the $4,000,000 "contribution" imposed on Lombardy in his Italian campaign, and the $2,- 400,000 exacted from Parma and Modena, had paid the cost of war. The $8,000,000 indemnity exacted from Vienna after Austerlitz came very near to serving a similar purpose in the campaign of 1805. The imitation of this procedure hy the German generals, in their Belgian campaign of 1 9 14, was not even mentioned at Berlin as a help toward paying war expenses. It had no effect whatever, except to expose the authors of the ^ cruel exaction to the scorn and contempt of the outside world.

But the vastly larger cost of present-day warfare was not the only consideration which prevented drawing of confident analogies from the economic results of war a century ago. When the treaty of Amiens between France and England was broken in 1803, international finance and international foreign trade were in their infancy. Judged by its scope and methods of to-day, foreign commerce was conducted in a fashion which may fairly be described as primitive. International banking and investment were hardly in their beginning; the house of Rothschild, for example, dates its origin from the days of disordered continental finance and great English public loans which came with the Napoleonic wars. No belligerent state, therefore, was confronted with enormous sales, on its stock exchanges, of securities held in the enemy markets. As a matter of fact, the London Stock Exchange remained open during the whole of the Napoleonic wars ; not even such precaution as arbitrary "minimtmi prices" was imposed by government. The price of Great Britain's 3 per cent consols did indeed decline from 80 or 90 to the neighborhood of 50; but it was lowest at the beginning' of the war. Thereafter, notwithstanding the then unprecedented output of new government securities by England, the price of consols rose and fell purely in response to news from the campaign; in general, the price was considerably higher than at the beginning of hostilities.

Government bonds were indeed almost the only quarter in which the rapidly accruing capital of Europe could be invested; at London, the only alternatives of real importance were the very limited field provided by shares of the Bank of England and the East India Company, and the very speculative and precarious field provided by joint-stock ventures in merchant ships and cargoes. The extremely intricate problem, created in 1 9 14 by the enormous mass which every strong belligerent country held of securities and floating

OLD-TIME WAR EXPERIENCES 13

loans of foreign, including enemy, communities, did not therefore exist at all. But, on the other hand, the strain on the gold reserves of the fighting nations was most formidable. At London almost the first financial event in the long French war of a century ago was suspension of gold payment on its circulating notes by the Bank of England. An open premium of 20 to 40 per cent on gold was the necessary consequence; then a discoimt of 16 per cent or more on English drafts presented in the foreign exchange markets of such great commercial cities as Amsterdam and Hamburg.

Merchant vessels sailing for other destinations than these banking centres carried gold and silver in their strong boxes, and, though they commonly moved in convoy, escorted by ships of war, they were the rich prizes of the maritime campaign. An extensive smugglers' trade, with headquarters in the Channel Islands, largely defeated the blockade of France and its possessions by the British fleet. One of the incidents of that war was the establishment, from the unguarded seaports in Finland or Dalmatia, of a land route through which, in wagons or sledges drawn by relays of horses, contraband merchandise was carried from England across the Continent to Germany and France — at a cost said to have been fifty times the freight rate, then existing, from London to Calcutta. In short, the confusion into which the present war plunged international finance, directed itself a century ago to ocean trade. Such international banking problems as existed were created wholly by this exchange of merchandise. When the British Government, dining the Napoleonic wars, paid its famous subsidies to the German states, the most efficient means of doing it was found to be through a three-cornered operation, based on the foreign trade of the United States. With neither of the great belligerents in control of the sea, and with French and English frigates cruising along the ocean routes to capture enemy merchant ships, the merchants of neutral America, whose export trade in products of the United States was small, developed a lucrative business in carrying West Indian products to England and continental Europe and bringing back English manufactures for home consiimption. On the English markets, these merchants bought far more than they sold; on the Continent they sold far more than they bought. The British Government therefore bought from the London merchants their claims on American importers and sent them to the German money markets, where the American traders' claims on German merchants were accepted in payment; such mercantile drafts on Germany being then used for payment of the

WHAT WAS EXPECTED IN 1914 15

British exchequer's subsidies to the German princes.

It was not difficult to see, even in August, 19 14, how httle of sure analogy as to probable economic results in the new European War could be based on these experiences of the last great conflict of a similar scope. The immense expansion of international trade and banking which had marked the century since the battle of Waterloo; the complete change which had occurred in the investment of capital; the enormously complicated machinery of debits and credits, assets and liabilities, as between all of the great financial markets — these were aspects of the situation such as could only confuse and bewilder the financial mind. It was perfectly evident when this war began that, whatever were to be the actual economic phenomena created by it, they would not be the comparatively simple problems of 1793 and 1803 and 18 12, but something vastly more difficult for the financial markets to surmoimt without world-wide collapse of credit.

Since, then, we have seen how little light history could throw on the probable economic events of the war of 19 14, it will be interesting to inquire what experienced financiers expected to occur as an immediate consequence of its outbreak. Minds of the greatest bankers, in every market of the world, had been absorbed in this question for i6 PRECEDENT AND PREDICTION

a generation. Despite their incredulity as to the willingness of any government to provoke such a war, the possibility was never absent from their calculations. The largest financial interests in the world were at stake in their judgment as to the immediate economic sequel.

The question, what results they actually looked for, is not at all difficult to answer. It was well understood beforehand that, in the economic as well as in the military field, forces would be called into play such as would test with the utmost severity the financial endurance of the belligerent communities. But, as regards specific results, the coiu-se of events in the world's economic history since the war began, as in the strategy of the war itself, has been a chapter of surprises. With a single exception — the French calculation, already referred to, that a war involving six European Powers would cost at least $50,000,000 per day, which has been more than realized — every prediction of the immediate financial and economic sequel hit wide of the mark.

First, general insolvency would be inevitable, with bankruptcy of the most important international houses — owing to the sudden embargo on collection of the enormous mass of credits outstanding to their account in other countries. That prophecy has not been fulfilled at all; there have been fewer of such bankruptcies, either in bellig-

SIR EDWARD GREY'S PROPHECY 17

erent or neutral states, than in an ordinary "panic year" like 1866 or 1873. Second, outbreak of general European war would break down international trade completely; partly because of the crumbling away of credit, partly because of hostile navies on the sea. As late as July 23, 19 14, only a week before the German ultimatimis, Sir Edward Grey predicted to the British ambassador at Vienna that "if four great Powers — say Austria, Russia, France, and Germany — engaged in war, the war would be accompanied or followed by a complete collapse in European trade and industry." All of the designated great Powers, and with them England and Italy, have been for two years at war; yet, except for the foreign commerce of Germany and Austria, the prediction is unfulfilled. The problem of the commercial world to-day is a problem, not of available supply and demand for merchandise in foreign trade, but of available ships to carry it.

Third, liquidation of Europe's investments in neutral countries, with a view to raising money for the war loans, would proceed on such a scale as to force a 20 or 30 per cent break in the price even of American securities (of which the outside world held something like $4,000,000,000), with all the financial consequences which such sudden change in basic values would involve. With the unprecedented war-time output of new government securities in Europe, demand on the whole world's investment capital would so immensely exceed available supply as to make this decline in existing securities progressive, even in the markets of neutral states. The prediction has wholly missed fulfilment. Belligerent Europe has in actual fact sold back to the United States during the progress of the war more than $1,500,000,000 of American securities; yet prices for American stocks and bonds, after eighteen months of fighting, were higher than when the war broke out, and, instead of the predicted panicky break on the stock exchanges, the second year of the European War was distinguished on the American markets by an exceedingly violent speculation for the rise.

Finally — and this belief persisted during several months of the war itself — the wholesale recall of belligerent Europe's capital from neutral markets, and especially the throwing back upon them of the securities previously sold by them to Europe, would result in drawing all the gold of neutral states into the European banks, with resultant collapse of bank reserves in such neutral markets, complete upsetting of their credit, and extreme advances in their money rates. None of the prophecies has been so amazingly falsified as this. Not only was the American market's importation of gold, in 1915, larger by $300,000,000 than in any previous year of its history, with

UNLOOKED-FOR RESULTS 19

the inflow continuing during 19 16, but the accumulation of gold in such other neutral states as Holland and Sweden was so abnormally rapid that, reversing all previous financial practice, measures were actually taken by the banks of those two countries to discourage further imports, lest the mere fact of overflowing bank reserves should provoke unwholesome speculation. Reserves of the American banks passed far beyond their previous maximum. As for the money market, New York was destined to be confronted, after 19 14, with one of the longest consecutive periods of extremely low money rates in its history.

Such was the series of erroneous and misleading expectations with which the whole financial community of the world, and especially that of England, entered the period of war. It will now be our task to survey the actual course of economic events; to inquire why results imexpected by the most competent financiers actually came to pass and why the expected results did not, and then to see how far, on the basis either of past or present experience, we can map out the horoscope for the aftermath of war.

Chapter II The War Panic

WITH what spectacular suddenness the great European War, for whose possible occurrence financial Europe had during forty years been watching apprehensively, at last broke out at the end of July, 19 14, no one who lived through that period is likely to forget. The sense of incredulity; the insistence that such a thing was not possible in our time ; the final bewildering whirl of events, remembered by most people only as a cloud of confusion until the German advance on Paris, with the French and English armies retreating before the triumphant invader, emerged as a concrete fact — ^what aU this signified in America it signified in Europe also, and in the great financial markets of Eiu"ope as well as among the people at large.

Except for a general sense that events crowded on one another's heels with such rapidity that the latest bulletin of the newspaper "extra" went far toward blotting out recollection of what had gone before, few people even to-day remember what actually happened in that period of confusion. This was, and is, as true of the financial com-

ON THE EVE OF WAR 21

munity as of the community at large. Austria's ultimatum to Servia created, in the hasty view of the reader of the despatches, the sense that a crisis had arisen which, because of its very gravity, must somehow be surmoiinted. In another week both Austria and Servia were lost to sight in the rush of larger consequences elsewhere on the map of Europe. For a single day the firing by the troops on the Dublin rioters seemed to be the event of paramount significance; then it was forgotten for a year. The predicament of American tourists, imable to get away from the area of fighting, held the centre of the news for a period only a little longer. How slowly the comprehension of what was actually happening swept over even the financial mind may be forcibly recalled by the episode of the North German Lloyd steamer Kronprinzessin Cecilie, whose departure from New York for a German port on Tuesday, July 28, with $10,000,000 gold on board, consigned one-half to London and one-half to Paris, was discussed on Wall Street with more amusement than concern, as proving the imreality of the talk of war, tmtil the news arrived of her sudden turning back in mid-ocean and of her race to reach an American port before the English cruisers should intercept her.