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'Borrowers Should not use their library privileges for : thebenefitof other persons. Books o^ special value and gift books, when the giver wishes it, are not allowed to circulate. ' Readers are asked to i-e- port all cases of books ' marked or mutilated. Do not deface bo^^s by marks and writing. HJ236 .F%T" """"""" '"'""* Intejjiationai finance and its reorganiza ,. 3 1924 032 544 680 oiin Digitized by Microsoft© This book was digitized by Microsoft Corporation in cooperation witli Cornell University Libraries, 2007. You may use and print this copy in limited quantity for your personal purposes, but may not distribute or provide access to it (or modified or partial versions of it) for revenue-generating or other commercial purposes. Digitized by Microsoft® Digitized by Microsoft® Digitized by Microsoft® INTERNATIONAL FINANCE AND ITS REORGANIZATION Digitized by Microsoft® OTHER BOOKS By ELISHA M. FRIEDMAN Editor of AMERICAN PROBLEMS OF RECONSTRUCTION A National Symposium on the Economic and Financial Aspects With a Foreword by Franklin K. Lane Laie Secretary of the Interior AMERICA AND THE NEW ERA Chapters ifl Social Reconetructioii With a Foreword by HEKBflRt Hoover Secretary of Commerce Author of LABOR AND RECONSTRUCTION IN EUROPE With an Introduction by William B. Wilson Ex-Secretary of Labor INTERNATIONAL COMMERCE AND RECONSTRUCTION With a Foreword by Joseph French Johnson Dean of New York University School of Commerce E, P. BUTTON & COMPANY Digitized by Microsoft® INTERNATIONAL FINANCE 'and its REORGANIZATION BY ELISHA M. FRIEDMAN Lecture on Finance, New York University, School of Commerce, Accounts and Finance; Sometime Statistician, War Finance Corporation; Author of "International Commerce and Reconstruction," etc. NEW YORK E. P. DUTTON & COMPANY 68 1 Fifth Avenue n Digitized by Microsoft® COPVKIOHT 1922, BY ^;_ E. p. DUTTON & COMPANY All Rights Reserved Asife^si Printed in the United Statet of Amtriea ^h f d A n I' I . I Digitized by Microsoft® , ^/ TO A. BARTON HEPBURN AND PAUL M. WARBURG BANKERS WHO HAVE MAINTAINED TRADITIONS OF SCHOLARSHIP AND PUBLIC SERVICE; PIONEERS IN CDRRENCY EEEORM AND IN THE DEVELOPMENT OP THE BANKING SYSTEM TO SERVE AMERICA IN HER NEW INTERNATIONAL POSITION Digitized by Microsoft® Digitized by Microsoft® PREFACE If Hegel's dictum, "we learn from history that we learn noth- ing from history" is true, it is because mankind failed to view history objectively and hitherto regarded itself as the material of a blind evolution rather than as the director of the social processes. Nations responded unconsciously to the forces of the day and un- critically expressed the emotions that dominate group behavior. The dissemination of the scientific attitude, the observation of the events of history as laboratory variants, may help the world to learn from experience and to avoid the repetition of much misery and suffering. The World War may be conceived as a vast experiment in international finance, conducted at the cost of over I2 million lives and over 200 biUion dollars. Its lessons should be an open book for the generations to come. England, France and Germany utilized three different methods in financing the war. The con- sequences in each of these countries are a foil to the conflicting theories of war finance, advanced during the struggle. The results test the hypotheses. A knowledge of the history and diagnosis of the financial ills of Europe are essential to the determination of the prognosis and the therapy. The present chaos in Europe can be understood only in the light of its causes, and the possible way out is to be found only by studying the effects of war-time finance. The aim of this book is to present a concise account of the financial changes in Europe during and since the war, and a sum- mary of the proposals for financial reconstruction. It covers the period from 1914 to 1921 and treats the questions of foreign ex- change, banking and public finance with reference to the three Digitized by Microsoft® viii PREFACE major belligerents. The methods of war finance are compared and appraised, and an attempt is made to outline the prospect, and the measures taken or recommended to hasten the return of stable conditions. The ending of the war has made it possible to discuss scientifically and assess impartially questions on which war loyal- ties warped the judgment. Countries other than Great Britain, France and Germany are considered only incidentally. Except in the discussion of exchange rates in the United States, our own country is not included, chiefly because most American readers are more or less familiar with the methods and effects of its financing of the war and because the United States has not been as seriously affected as the European belligerents, and the burden of its debt is not impossible to bear. Our after-war financial problem involves not a doubt as to the possibility of a solution, but rather a choice of procedures. It is hoped that the book will be of value to thpse interested in public and private finance, either as students or as business men. The volume is the last of the series of studies on the economic effects of the war, written by the author as a result of a conver- sation in November, 1917, with Mr. John Macrae. It was written during seven months of retirement and after a considerably longer period of gathering of material. Grateful acknowledgment is made of obligation to Professors H. C. Adams of the University of Michigan, T. S. Adams of Yale University, and E. L. Bogart of the University of Illinois, to whom the writer submitted an analytical outline of the collected material in the summer of 1920 in Washington and who urged him to write the book. Thanks for comment and valuable sug- gestions concerning the manuscript are due to Professors E. R. A. Seligman and E. L. Bogart, and to Mr. L. R. Gottlieb, in the section on public finance; to Professors H. Parker Willis and Harold G. Moulton, in the section on banking, to Mr. Fred I. Kent, vice-president of the Bankers Trust Company and during the war Director of the Division of Foreign Exchange of the Federal Reserve Board, and to Dr. Raleigh S. Rife, economist of the Guaranty Trust Company in the section on foreign exchange, and to my colleague Professor Charles W. Gerstenberg of New York University for general suggestions. The chapters dealing with each of the three countries were submitted for criticism to Digitized by Microsoft® PREFACE IX representatives of these governments, then In the United States, Mr. John Joyce Broderick, and Mr. H. C. A. Carpenter, respect- ively Commercial Counsellor and Commercial Secretary of the British Embassy at Washington;. Mr. J. A. M. DeSanchez, Di- rector of the Division of Economics of the French Commission in the United States, and Mr. Ludwig Bendix, Chief of the Division of Foreign Exchange of the German Ministry of Economics. How- ever, the views expressed are the author's alone. The author is indebted to Undersecretary of the Treasury, S. P. Gilbert, Jr.; Ex- Assistant Secretary N. Kelley; Mr. John Foster Dulles, some- time legal adviser to the American Commission to Negotiate Peace; Mr. Carl Snyder, Statistician of the Federal Reserve Bank of New York; Dr. C. E. McGuire of the Inter- American High Commission; Dr. Arthur N. Young of the State Department; to Mr. Malcolm C. Rorty of the American Telegraph and Tele- phone Company who kindly read portions of the material, and to Mr. C. C. Latour of the American International Corporation, who was good enough to read the galley proof. However, none are to be held accountable for the statements of fact or opinion in the book. For the use of the illustrations, the author is indebted to Pro- fessor Wesley C. Mitchell's "International Price Comparisons," (for Figures I, II and III), and to the editors of the Harvard Review of Economic Statistics, (for Figures VI, VII, IX and XI), of the Monthly Review of the Federal Reserve Bank of New York (for Figures IV, XXI and XXII), of the Federal Reserve Bulletin, (for Figures V, VIII, X, XII, XIV, XVI and XVII), and to the Secretary of the War Finance Corporation, (for Figures XIII, XV, XVIII, XIX and XX). For cooperation in the col- lection of material, acknowledgment is made of the aid of Mr. Wesley Frost, sometime Acting Foreign Trade Adyiser in the Department of State and Mr. M. L. Jacobson, Statistician of the Federal Reserve Board, former colleagues of the author on the Economic Liaison Committee of the Federal Grovernment Depart- ments, and of the aid of Dr. Henry J. Harris of the Division of Documents of the Library of Congress, and of the stalls of the library of the Federal Reserve Board at Washington, of the Guar- anty Trust Company, of New York University, and of the Di- vision of Economics, Statistics and Public Documents of the New Digitized by Microsoft® X PEEFACE York Public Library. Not least are sincere thanks due to a few friends, who subscribed to advance copies to the number required by the publishers. E. M. F. 14 Wall Street, October 35, 1921. Note: Where dollar equivalents of foreign currencies are given, the conversion is at mint parity, unless otheridse specified. The footnotes refer to collateral readings as well as to sources of data in the text. Digitized by Microsoft® CONTENTS SECTION A THE EFFECTS OF THE WAR Part I. — Public Debt and Taxation CHAPTER PAGE I. Principles an'd Practice in the World War i II. British Public Finance 57 III. French Public Finance 93 IV. German Public Finance , 135 Part II. — Currency and Credit V. Principles and Practice in the World War 173 yi. British Currency and Credit 193 VII. French Currency and Credit 219 VIII. German Currency and Credit 258 Part III. — Foreign Exchange 1 IX. Principles and Practice in the World War 291 X British Foreign Exchange 405 XL French Foreign Exchange 432 XII. German Foreign Exchange 449 SECTION B FACTORS IN THE FINANCIAL REORGANIZATION XIII. The Capital Levy 485 XIV. National Bankruptcies in the Nineteenth Century 523 XV, The Inter- Allied Debts— Shall They be Cancelled?., 539 Digitized by Microsoft® XU CONTENTS PAGE XVI. The German Indemnity 585 XVII. The Foreign Exchanges 610 XVIII. The Brussels Financial Conference 617 XIX. International Loans for the Kestoration of Europe 638 XX. New York and London as Financial Centers 658 Bibliography 675 Index of Authors 691 Subject Index > 695 Digitized by Microsoft® Analytical Table of Contents SECTION A THE EFFECTS OF THE WAR PART I PUBLIC DEBT AND TAXATION CHAPTER I PRINCIPLES AND PRACTICE IN THE WORLD WAR PAGE A. The Theory of War Finance i i. Goods versus Credit ii. Inflation a. Causes of Inflation b. The Nature of Inflation c. The Results and Evils of Inflation iii. The Burden of the Present or the Future Generation iv. Taxes versus Loans a. Loans X. The Argument for Bonds 2. The Argument against Bonds 3. Effects of Loan Policy in War of 181a b. Taxation I. The Argument for Taxes 3. The Argument against Taxes 3. Conclusion c. Combination of Loans and Taxes 1. The Theory 2. The Practice B. National Wealth and War Debts 18 i. National Wealth ii. Real Wealth and the Paper Debt iii. The Future Outlook xiii Digitized by Microsoft® XIV ANALYTICAL TABLE OF CONTENTS PAGE C. Statistics of Public Finance »5 i. National Wealth and Income ii. Growth of Public Debt of the Nations iii. The Cost of Previous Wars iv. Growth of World Revenue D. Total Cost of the War •jj^.^i. 3' i. Errors in Estimating the Cost a. The Time Factor b. The Currency Factor c. The Administrative and Accounting Factors d. International Aspects ii. The Direct Costs of die War a. The Total Direct Cost b. Loans 1. Public Debt of Belligerents 2. Debt Charges 3. Per Capita Debt 4. Debt and National Wealth; Debt Charges and Na- tional Income 5. Inter-Allied Loans c. Taxes 1. Ratio of Taxes to Expenditure 2. Total Taxes and War Taxes Per Capita Per Annum 3. Sources of Revenue and Relative Increases in Taxes a. Direct taxes to total taxes b. Relative increase in direct taxes c. Relative increase in total receipts d. Ratio of total taxes to expenditures d. Increase in Note Circulation iii. Indirect Costs of the War a. Loss of life b. Loss of Property c. War Relief d. Losses of Neutrals e. Loss of Current Wealth f. Social Unrest g. Total Indirect Costs h. Compensations CHAPTER II ' BRITISH PUBLIC FINANCE A. Pre- War Situation and Cost of the War 57 B. Loans 60 i. Ways and Means Advances ii. Treasury Bills iii. Exchequer Bonds iv. Long-Term Bonds a. Inducements to Subscribe b. Control of Capital Issues Digitized by Microsoft® ANALYTICAL TABLE OF CONTENTS XV PAGE I. Procedure Z. Effects V. War Savings Certificates vi. Foreign Borrowings a. Unsecured Loans b. Treasury Bills c. Mobilization of Securities d. Secured Loans e. Financial Impasse f. United States Government Advances g. Loans to Allies and Dominions h. Total Foreign Borrowings C Taxes 74 i. The Taxation Policy ii. Direct Taxes a. Income Tax b. Excess-Profits Tax iii. Indirect Taxes a. Customs and Excise Taxes b. Consumption and Luxury Taxes c Non-Tax Revenues D. Problems of the Post-War Budget 78 i. Comparison of Pre- War and Post- War Budgets ii. Meeting the Deficit a. Extent and Cause of the Deficit b. Wiping Out the Deficit iii. Maturing and Floating Debt E. An Appraisal of British War Finance 85 i. Availability of Funds a. Moderate Rise of Interest Rates b. No Lottery Loans Issued ii. Fiscal Policy Unchanged Throughout the War iii. Democratic versus Militaristic Finance iv. The Outlook a. A Retrospect bf The Prospect CHAPTER III FRENCH PUBLIC FINANCE A. Pre-War Situation 93 B. Loans 95 i. Cost of the War ii. Analysis of the Public Debt a. Growth of the Debt Analyzed b. Analysis of the Total Debt iii. Advances from the Bank of France iv. Short-Term Loans V. Long-Term Loans Digitized by Microsoft® xvi ANALYTICAL TABLE OF CONTENTS PAGE vi. Foreign Borrowing a. Long and Short-Term Loans b. Analysis of the Foreign Debt c. Offset to Foreign Borrowing C. Taxes "9 i. Principles and Policies a. Analysis of Revenues b. French and British Taxes Compared c. The Amount of War Taxes and Percentage of Total Cost d. Diversity of Taxes e. Criticism of Tax Policy f. An Apology for the Tax Policy ii. The Income Tax iii. Profits Taxes iv. Indirect and Other Taxes D. The Post-War Budget "7 i. Sections of the Budget ii. The Budget of 1920 iii. Tax Increases E. Appraisal of French War Finance 123 i. Facts ii. The Effects of French Financial Policy a. Bank of France Advances b. Short-Term Loans c. Long-Term Loans d. Taxes e. Change of Fiscal Policy iii. The Causes of the Difficulty a. Bad Pre- War Situation b. The Theory of a Short War iv. The Remedy V. The Outlook a. The Indemnity b. The Future Budget c. The French Diagnosis d. The American View CHAPTER IV GERMAN PUBLIC FINANCE A. Cost of the War and Public Debt 13S i. National Wealth and National Debt before the War ii. The War Debt of the States and Cities iii. The Growth of the Debt iv. Total Debt Analyzed B. Loans 140 I. The Theory of German War Finance ii. The Mobilization of Credit, an Accessory to the Loan Policy Digitized by Microsoft® ANALVTICAl TABtE OF CONTENTS XVH PACE lit The Issue of Loans a. The Restriction of Capital Issues b. Terms of Loans c. The Lottery Loan C. War-Time Taxation 146 i. Taxation Policy ii. Principles of Taxation iii. Taxes Enacted a. War Increment Tax b. Company Profits Tax c. Other Federal Taxes d. Non-Federal Taxes D. The Bcdget 149 i. Total Requirements ii. Deficits iii. Budget Comparisons E. The Appraisal of German War Finance 155 i. The Debt ii. Taxation F. Taxation After the Armistice 157 i. Indirect Taxes ii. Direct Taxes on Income and Profits a. Taxes on Income b. Taxes on Income from Investments c Taxes on War-Time Increases of Income d. Taxes on Corporate Profits iii. Property Taxes a. Recurrent Levy on Increases of Wealth b. Inheritance Tax iv. The Effect of Heavy Taxation a. The Flight of Capital b. The Effects of the Flight of Capital C. Counter Measures I. The Restriction of Emigration a. The Control of the Export of Capital 3. The Issue of New Money 4. Bank Control of Income from Investments G. The Outlook , , 167 i. Further Inflation and Bankruptcy Proposed ii. Increasing the National Revenue iii. Germany's Losses iv. Pieiequiaites for Payment of Indemnity Digitized by Microsoft® tviii ANAtYTICAX TABLE OP CONTENTS PART II CURRENCY AND CREDIT CHAPTER V PRINCIPLES AND PRACTICE IN THE WORLD WAK PAGE A. Inflation and the Central Banks , 173 i. How Inflation is Produced ii. Peace Conditions vs. War Conditions B. Government Bank Statements 175 i. Changes in Statements of Banks of Neutral and Belligerent States ii. Changes in the Items on BanI: Statements C. Effects of Inflation on Prices 181 D. Prospects and Remedies 188 i. The Prospect Ii. Policies a. Credit and Currency Before and During the War b. Post-War Policies CHAPTER VI BRITISH CURRENCY AND CREDIT A. The Bank of England, Development and Organization 19J B. Wartime Legislation and Expedients 195 i. The Moratorium ii. Suspension of the Bank Act iii. Issue of Currency Notes C. The Bank of England During the War 198 i. The Bank Statement and the Currency Situation ii. Changes in the Bank of England Statement D. Effects of Inflation 207 1. Increase of Prices ii. Increase of Wages iii. Premium on Gold iv. Increase in Accounts of Private Banks E. Post-War Policy. 211 i. Efficacy of Bank Act Before the War ii. The Breakdown of the Bank Act During the War iii. The Prerequisites for the Restoration of the Gold Standard a. Cessation of Government Borrowing b. The Utilization of the Discount Rate Limitation of the Fiduciary Issue iv. Maintenance of the Bank Charter Act of 1844 Digitized by Microsoft® ANALYTICAL TABLE OF CONTENTS XIX CHAPTER VII FRENCH CURRENCY AND CREDIT PAGE A. The History of French Banking aig i. Development of the Bank of France ii. Organization and Functions of the Bank of France a. Ownership and Control b. Rate of Discount c Private Banks d. Notes vs. Deposit Credit e. Foreign Investments B. War-Time Financial Legislation 224 i. The Moratorium ii. Suspension of Specie Payment and the Issue of Legal Tender Notes C. War Operations of the Bank of France 226 i. Changes in the Statement of the Bank of France ii. Gold Policy a. The Pre-War Conditions b. The Effect of the War c. An Appraisal of the French Gold Policy iii. Advances to the State a. Terms of Advances b. Relative Importance of Advances to the State c. Advances to Foreign Governments d. Repayment of Government Advances e.' Advances after the Armistice f. Amortization Fund iv. Loans and Discounts a. Decline During the War b. The Rates of Discount V. Moratorium Bills vi. Notes in Circulation a. Terms of Issue b. Forms of Issue c. The Continuous Increase in Volume vii. Minor Operations of the Bank of France D. The Effects of Inflation 242 i. The Rise in Prices ii. Economic Disturbances iii. Depreciation of Foreign Exchange iv. Premium on Specie V. Shortage of Specie and Demonetization vi. Issue of Paper Money of Small Denominations vii. The Disruption of the Latin Monetary Union viii. Popularization of Checks ix. Private Banks Affected E. The Outlook 854 i. The Expansion of Production to Absorb the Increased Currency ii. Deflation of the Currency Digitized by Microsoft® XK ANALYTICAL TABLE OF CONTENTS PACE iii. Analogy of the Civil War iv. Possible Remedy CHAPTER VIII GERMAN CURRENCY AND CREDIT A. History of the Reichsbank »S8 i. Development of the Central Bank ii. Organization and Function of the Reichsbank iii. Control and Concentration of Gold Supply B. War LEGisLATioNr, Policy and Expedients 260 i. Suspension of Specie Payment ii. Imperial Treasury Notes Issued iii. Increased Issue of Reichsbank Notes iv. New Institutions to Create Credit V. Moratorium C. Operations of the Reichsbank During the War 264 i. Gold Policy of the Reichsbank a. Changes in Gold Holdings During the War b. War Measures to Increase Gold Holdings ii. Commercial Bills and Discounted Treasury Bills a. Intermittent Increases up to the Armistice b. Great Increases After the Armistice iii. Note Issues a. Increases by Years b. Analysis of Total Notes in Circulation c. The Causes of the Increase in Note Circulation d. Measures for Relieving the Lack of Currency X. Note Issues by Towns and Chambers of Commerce z. The Use of Interest Coupons 3. Private Printing Establishments Utilized e. Loan Bureau Notes, Darlehnskassenscheine f. Imperial Treasury Notes, Reichskassenscheine iv. Deposits D. Effects of Inflation 879 i. Depreciation of Currency ii. Rise in Prices a. Course of Rise b. Extent of the Rise c. The Lag in Wages and Cost of Living iii. The Increase of Deposits and Profits a. The Reichsbank Turnover and Profits b. The Effect on the Private Banks c. Increase of Savings Banks Deposits d. Increased Profits in Industry E. The Outlook ^ij i. Gradual Deflation not Feasible ii. The Position under Depreciated Paper iii. Internal Measures as Remedies iv. Allies' Policies as Remedies Digitized by Microsoft® ANALYTICAL TABLE OF CONTENTS ZZl PART III FOREIGN EXCHANGE CHAPTER IX PRINCIPLES AND PRACTICE IN THE WORLD WAR A. The Theory of Foreign Exchange 291 i. Determinants of Exchange Rates a. Commodity Movements b. The Flow of Capital c. Remittances of Funds d. Drafts for Services Performed e. Summary ii. The Trade Balance of the United States iii. History of the Trade Balance of the United States a. Resume b. The Pre-War Period c. The War Period d. The Outlook iv- Arbitrage a. High Rates in Copenhagen b. High Rates in New York v. Correctives a. Between Countries on Gold Basis 1. Changes in the Gold Supply 2. Changes in Rates 3. Changes in the Volume of Goods b. Between Countries on a Non-Gold Basis, If Gold Flows 1. Changes in Gold Supply 2. Changes in Rates 3. Changes in the Volume of Goods c. Between Countries on a Non-Gold Basis, if Gold Does Not Flow I. Changes in Volume of Goods it. Changes in Rates d. Summary B. Quotations 308 i. New York Rates on Allied Powers in the World War a. From August, 1914, to April, 1917 b. From April, 1917, to March, 1919 c. After March, 1919 ii. New York Rates on Neutral Powers a. From August, 1914, to April, 1917 b. From April, 1917, to March, 1919 c. After March, 1919 iii. Currency of the Central Powers a. From August, 1914, to April, 1917 b. During the Belligerency of the United States c. After July, 1919 Digitized by Microsoft® 3001 ANALYTICAL TABLE OF CONTENTS PAGE C. The Causes of Exchange Fluctuations 329 i. Commercial Factors a. Before "Pegging" Sterling b. During the "Peg" c. After the Release of the "Peg" ii. Fiscal Factors iii. Political and Other Factors D. The Effects of Depreciation of the Foreign Eschange 334 i. The Self-Corrective Effect of Depreciation a. Commercial Self-Correctives 1. Exports are Fostered 2. Imports are Checked 3. Explanation b. Financial Self-Correctives ii. Denial of the Self-Corrective Effects of Depreciated Exchange a. Commercial b, Financial iii. Reconciliation of the Apparently Conflicting Facts a. Commercial vs. Fiscal Causes of Depreciation b. Relation between Fall of Exchange and Rise of Prices iv. The Unsettling Effect of Unstable Exchange Rates a. Commercial b. Financial v. The Increased Importance of Dollar Exchange a. Wider Arbitrage Transactions b. Development of Dollar Exchange E. The Correctives of Foreign Exchange 34,5 i. Commodity Movements a. During the War b. After the War ii. Flovy of Gold a. Prior to the War b. Flow of Gold During the War 1. Before the Belligerency of the United States 2. The Flow of Gold Under the Embargo c The Flow of Gold After the War 1. Lifting of the Embargo S. The Effects of the Lifting of the Embargo iii. The Resale of American Securities a. Railorad Shares b. Industrial Securities iv. Sales of European Securities a. Industrial Stocks I. Royal Dutch Shares a. "Shell" Shares 3. Rand Shares 4. De Beers Shares b. Internal Bonds of Governments and Municipalities v< Loans a. Short-Term Bills 1. Under Normal Conditions 2. Treasury Bills Digitized by Microsoft® ANALYTICAL TABLE OF CONTENTS XSU PAGE 3, Bank Balances b. Long-Term Loans 1. Floated Before the Armistice 2. Floated After the Armistice 3. Investment Trusts a. European Investment Trusts b, American Investment Trusts 4. The War Finance Corporation 5. Edge Law Corporations a. The Law b. Companies Formed vi. The Control of the Movement of Capital a. Control of the Movement of Capital in the United States b. Control of the Movement cf Capital by Foreign Coun- tries Stabilization of the Allied Exchange in New York 371 i. Mechanism of the "Peg" a. United States Government Advances to the Allies 1. The Law 2. The Amounts 3. The Form of the Debt 4. The Rate of Interest 5. Maturity of the Principal b. The Expenditures of the United States Army Abroad c Credits for the Purchase of Army Property and of Guaranteed Wheat d. British Treasury Bills c. Licensing of Dealers in Exchange ii. The Effects of the "Peg" a. The Effect on the Allied Powers 1. The Maintenance of an Artificial Level 2. The Failure of the Self-Correctives 3. Financial Weakness Concealed 4. Strengthening of British Prestige a. Sales of Sterling between United States Dealers b. Sales of Sterling by Foreign Holders c. British Operations in Neutral Currencies b. Effect on Neutrals 1. Trade Currents 2. DifBculties in Allied Settlements for Trade Balances 3. Arbitrage in Allied Exchanges a. Mode of Operation b. The Defeat. of the Aim of Stabilization c. The Effect of Arbitrage 4. Heavy 'Flow of Gold to Neutrals C. The Effect on the United States 1. Depreciation of Dollars 2. American Paymaster for the Allies 3. Gold Embargo 4. Commercial Effects of the "Peg" iii. Correctives of the Depreciation of the Dollar on Neutral Markets a. Proposed Correctives Digitized by Microsoft® Xxiv ANALYTICAL TABLE OF CONTENTS PAGE I. The Prohibition of Arbitrage a. The Tax on Exports to Neutrals 3. A Federal Reserve Foreign Bank b. Fundamental Difficulty I. Impossibility of Trade Settlement 3. Unavailability of Securities 3. Insufficiency of Gold c. Correctives in Effect 1. Borrowings by the United States a. The Law b. Loans Negotiated I, Neutrals of Europe X. Spain y. Switzerland z. Scandinavian Countries a. Neutrals of South America X, Argentina y. Other Countries 3. Japan 2. Borrowing by the Allies a. Spanish Loans to France b. Argentine Loans to Allies d. The Eflfects on Rates G. The Abandonment of Stabilization Expedients 396 i. Decontrol of Exchange ii. Reasons for the Release of the "Peg" a. Inability to Obtain Credit b. The Need for Return to Normal Conditions iii. Effects of the Release of the "Peg" a. The Sharp Decline of Exchanges in New York b. The Effect on Trade c. The EflFect on the Gold Market d. The Continued Liquidation of Securities CHAPTER X BRITISH FOREIGN EXCHANGE A. Causes of Depreciation ^05 i. The Nature of the Fluctuations ii. Merchandise Balance of Trade iii. The Decline of Invisible Credits iv. Loans to the Allies a. During the War b. After the War c. Sterling Remained the World's Currency d. The Palliative Character of Loans V. Inflation B. The Effects of Depreciation ,xo C. Correctives of Depreciated Exchange ah i. Merchandise Shipments Digitized by Microsoft® ANALYTICAL TABLE OF CONTENTS XXV PAGE ii. Gold Shipments a. Amounts b. The Embargo iii. The Flow of Capital a. The Resale of American Securities 1. The Procedure of the Dollar Securities Committee 2. Amounts Mobilized During the "Peg" 3. Sales After the Release of the "Peg" b. Sales of European Securities c. Foreign Borrowing I. Restrictions on the Exportation of Capital a. The Method and Effect h. The Removal of Restrictions i. Long-Term Loans 3. United States Government Advances 4. Treasury Bills and Short-Term Credits a. United States h. Japan c. Neutral Europe d. Argentina 5. Preferential Discount Rate IV. Other Correctives D. The Invisible Balance of Trade 4^6 1. Foreign Investments ii. War-Time Changes in Invisible Credits a. Investments b. Shipping Earnings c. Other Earnings d. Recapitulation CHAPTER XI FRENCH FOREIGN EXCHANGE A. Trade Balance 43a i. Total Investments ii. Classification by Countries iii. Foreign Loans and Borrowings During the War iv. The Post-War Position of France B. The Causes of Depreciation 435 i. Commercial Causes ii. Financial Causes iii. Fiscal and Currency Factors C. The Effects of Depreciation 437 i. Commercial Effects ii. Financial Effects a. The Breakdown of the Latin Monetary Union b. The Effect on Foreign Loans and Borrowing D. Correctives 440 t. Commercial Correctives Digitized by Microsoft® Ttxn ANALYTICAL TABLE OF CONTKNTS PAGE ii. Gold Shipments iii. The Flow of Capital a. Restrictions on the Export of Capital b. Sale of Securities c. Private Borrowing Abroad X. Mobilization of Securities e. Treasury Bills and Credits Opened a. In Great Britain b. In the United States c. Spain d. Japan e. In Other Countries 3. Long-Term Borrowings d. United States Government Advances e. The "Pegging" of Foreign Exchange CHAPTER XII GERMAN FOREIGN EXCHANGE A. Causes of the Fluctuation 450 i. Trade Causes a. Excess of Merchandise Imports b. Loss of Invisible Credits ii. Financial Causes a. Sales of Marks by Foreigners b. Maturing Loans c. Flight of Capital iii. Monetary Causes iv. Fiscal Causes V. Political Conditions a. Military Factors b. Internal Disorders c. International Restrictions d. International Cooperation B. The Effects of the Decline 457 i. The Effects on Prices a. The Gap Between German and World Prices t. The Facts Z, The Effects a. Rise in German Prices b. Inability to Deliver Goods for Export c. "Germany's Clearance Sale" b. Price Changes 1. The Fall in Exchange and the Rise in Prices 2. The Rise in Exchange and the Fall in Prices c. Lower Cost of Production d.\ Equalization of German and World Prices ii. Commercial Effects a. Stimulation of Exports b. Foreign Competition I. In the Home Markets Digitized by Microsoft® ANALYTICAL TABLE OF CONTENTS XXVU PAGE 2. In Foreign Markets c. Barter iii. Financial Effects a. The Rise in Price of Securities b. Increase in Capital Issues c. Investment by Foreigners, Economic Penetration and the Remedy d. Effect on German Bonds Abroad C. Correctives of Depreciation 47a i. Trade Correctives a. Self-Correctives b. Trade Policy c. Barter and Refining Credit ii. Gold Shipments iii. The Flov? of Capital a. Sale of Securities b. Foreign Speculation in Marks c. Borrowing by Germany 1. Borrowing in Holland 2. Borrowing in Switzerland 3. Borrowing in other Countries iv. Control of the Exchanges a. Trade Bills 1. Devisenordnung 2. Devisenbeschaffungsstelle 3. The Reichsbank b. Security Dealings V. Fiscal and Monetary Correctives SECTION B FACTORS IN THE FINANCIAL REORGANIZATION CHAPTER XIII THE CAPITAL LEVY IN GREAT BRITAIN AND OTHER COUNTRIES A. Is A Levy Necessary? 485 i. Distribution of Wealth ii. Difficulty in Balancing the Budget iii. The Evils of High Taxes iv. Deflation Increases the Burden of Taxation B. The Policy in Handling the Debt 487 _i. The Psychological Factor ii. Permanent vs. Maturing Public Debts iii. The Levy on Wealth C. Principles of a Capital Levy 489 i. The Problem and the Proposed Solution Digitized by Microsoft® XXviii ANALYTICAL TABLE OF CONTENTS PAGE ii. A Levy on Intangible Capital iii. A Capital Levy Would Supplement the Income Tax D. Misconceptions Concerning the Levy 49' i. Capital Levy is not a New Proposal ii. Capital Levy is Not Equivalent to Repudiation E. The Method of Payment 493 i. The Difficulty of Valuation a. The Per Cent Assessable b. Method of Valuation ii. Graduation and Assessment iii. Form of Payment iv. Evasion F. Advantages and Benefits Expected of a Levy 496 G. Objections to the Capital Levy 497 i. The Analogy to Military Conscription Erroneous ii. The Self-Corrective Nature of a Heavy Debt iii. Taxation, a Preferable Solution a. High Taxes are Accepted Facts b. The Tax Burden Inevitably Declines c. The Capital Levy as a Form of Income Tax iv. Capital is More Productive in Private Hands v. The Fear of a Repetition of a Capital Levy vi. Administrative Difficulties a. Capital not as Definite a Basis as Income b. A Large Percentage of British Property Difficult to Assess c. The Adjustment of Errors d. Fraud and Evasion vii. The Capital Levy a Panacea which Delays the Real Remedy H. Objections Answered 504 i. The Ethical Objection a. The Capital Levy is Unjust b. The Capital Levy Constitutes a Breach of Faith c. The Levy on Capital is Discriminatory ii. The Economic Objection a. The Levy Will Harm Industry and Commerce b. The Levy Will Deter Saving and Foster Extravagance iii. The Administrative Objection iv. The Danger of Repetition I. The War-Wealth Levy jofi i. The Justification of the War- Wealth Levy ii. The Objections to a War-Wealth Levy iii. The War-Wealth Levy vs. the Capital Levy iv. The Theory and Method of the War-Wealth Levy V. Conclusion of Committee on War-Wealth Levy J, Summary 5,, i. In Favor of the Levy ii. In Opposition to the Levy iii. Official Action Digitized by Microsoft® ANALYTICAL TABLE OF CONTENTS XXIX PAGE K. The Capital Levy in France 514 i. Theory ii. The Procedure L, Capital Levy in Germany Sifi i. The Discussion a. In Favor of a Properly Levy b. Against a Property Levy ii. The Laws a. Non-Recurrent Levy on Total Wealth b. Non-Recurrent Levy on War-Time Increases of Wealth M. CAPITAL Levy in Other Countries 521 CHAPTER XIV NATIONAL BANKRUPTCIES IN THE NINETEENTH CENTURY A. The Nature of National Bankruptcies 523 B. Types of National Bankruptcies 526 i. Default on Interest a. Reduction of the Rate of Interest b. Deferment of Payment c. Taxes on Interest ii. Default on Principal a. Postponement of Payment b. Conversion of Principal c. Reduction of the Principal d. Conversion of a Gold Debt into a Paper Debt iii. Native vs. Foreign Creditors C. Consequences and Liquidation of National Bankruptcy 530 i. Results of National Bankruptcies ii. Liquidation of National Bankruptcy D. Protection of Foreign Creditors 532 i. Guarantees ii. Intervention iii. Protective Committees iv. International Financial Control V. International Court CHAPTER XV THE INTER- ALLIED DEBTS— SHALL THEY BE CANCELED? A. Historic Experience 539 B. The Extent of the Debt 541 C. Types of Proposals 543 i. Partial Cancellation a. Cancellation of Interest and Payment of Principal b. Cancellation of Loans to France c. Partial Cancellation of Loans by Great Britain Digitized by Microsoft® «X ANALYTICAL TABLE OB CONTENTS PAGE ii. Redistribution of the Debts a. Offsetting Britain's Borrowings and Debts b. The Exchange of Inter-Allied Debts for German Indem- nity Bonds c. Pooling of the War Debts 1. French Proposals 2. Italian Proposals 3. British Proposals iiL Complete Cancellation of the Inter- Allied Debts a. British Proposals 1. History 2. By Keynes 3. By Home 4. By Lloyd George and Chamberlain b. American Proposals D. The Objections to Canceliatioh 554 i. American and Foreign Opposition ii. The Justification and Benefits Considered a. Financial I. Inability to Pay s. Hugeness of the Sum 3. Budget Deficits 4. The Unsettlement of Exchange Rates 5. Relatively Small Sacrifices of the United States 6. Dumping of European Goods b. Political Justifications 1. Payment of Indemnity by Victors 2. The Cost of Crushing Militarism 3. Imperiling of Peace iii. Arguments against Cancellation a. Heaviest Loss to the United States b. Crippling of International Credit c. Priority of Lien of Foreign Creditors E. Alternative Proposals jya i. The Intent a. Loans not Subsidies b. Military Exigency vs. Financial Prudence ii. Impossibility of Cash Payment a. E£Fect on Exchange Rates b. Payment in Foreign Securities c. Payment in American Territorial Possessions iii. Present Course a. The Law b. Deferment of Interest Payments c. Negotiations by the Secretary of the Treasury jv. Ultimate Course a. Not an American but an International Problem b. Cancellation not a Panacea c. Cancellation not an Unconditional Gift d. Prerequisites of Settlement V. The Need of an American Foreign Policy Digitized by Microsoft® ANAXYTICAL TABLE OF CONTENTS XXn CHAPTER XVI THE GERMAN INDEMNITY PAGE A. The French Indemnity of 1871 5*5 i. The Facts ii. A Comparison of the Indemnities of 1871 and 1921 B. Estimates of Property Damage 588 C. Proposed Indemnity 590 i. Treaty Provisions ii. The Hythe Conference iii. Boulogne and Spa Conferences iv. Paris Conference V. German Proposals vi. Final Terms Accepted by Germany D. Method of Payment 598 i. Surrender of Property ii. Payment in Kind iii. Negotiable Bonds E. Criticism i £03 i. Inability to Pay ii. Inability to Receive Payment iii. Cost of Reparation F. Conclusion fioy CHAPTER XVII THE FOREIGN EXCHANGES A. The Outlook 610 i. United States: Effect of Investments Abroad ii. Germany: The Effect of the Indemnity iii. International Trade Under Depreciated Paper B. Correctives 614 i. Infeasible Proposals ii. Financial Correctives iii. Trade Correctives CHAPTER XVIII THE BRUSSELS FINANCIAL CONFERENCE A. The Aim 617 ' B. The Diagnosis 6i8 C. Memoranda Submitted by Economists 620 D. Policies Recommended £22 i. Condemnation of Impracticable Proposals ii. The Abandonment of Certain National Policies iii. Positive National Policies Recommended iv. The Abandonment of Certain International Policies V. Positive International Policies Recommended E. Text of the Resolutions Adopted £26 F. An Appraisal of the Conference , >.. 63(; Digitized by Microsoft® XXxii ANALYTICAL TABLE OF CONTENTS CHAPTER XIX INTERNATIONAL LOANS FOR THE RESTORATION OF EUROPE PAGE A. The Need for International Loans ^3* B. The Prerequisite and Conditions of International Loans 639 C. Proposed Types of Loans *4i i. Loans by Government or an International Body a. Keynes' Proposal b. Paish's Proposal c. Vanderlip's Proposal d. Proposals of Delacroix and Pigou e. Proposals of Thalbitzer and Vissering ii. Private Loans a. The Views of Professor Cassel b. Proposal of Lehner D. The Ter-Meulen-Bruins Plan 649 i. Bruins' Outline a. Criticism b. The Conditions of Loans c. Private Credits d. Bruins' Plan ii. The Ter-Meulen Plan a. Summary and Text b. Recommendations c. Limitations of the Scheme d. An Appraisal of the Ter-Meulen Plan CHAPTER XX NEW YORK AND LONDON AS FINANCIAL CENTERS A. Before the War 638 i. Geographical Position ii. Industrial Maturity iii. Transshipment Trade iv. Financial Facilities V. Political and Other Factors B. During the War 663 i. The Decline of the Jobbing Trade ii. The Decline in Shipping iii. Foreign Exchange Arbitrage iv. The Federal Reserve System and the American Acceptance Market V. The Depreciation of Sterling vi. Other Financial Factors C. After the War 66S i. The Restoration of Commercial Prestige ii. Restoration of Financial Prestige D. The Outlook 671 i. Deficiencies of London ii. Deficiencies of New York Bibliography 675 Index of Authors 691 Subject Index., 695 Digitized by Microsoft® LIST OF CHARTS FIGURE PAGE I. Relative Prices before the War in United States and England 183 II. Relative Prices before the War in United States and France. 184 III. Relative Prices before the War in United States and Germany 185 IV. Relative Prices during the War in United States, England, France and Italy 187 V. Operations of the Bank of England during the War 202 VI. Operations of the Bank of England after the Armistice 203 VII. British Currency Notes and Bank of England Notes 207 VIII. Operations of the Bank of France during the War 228 IX. Operations of the Bank of France after the Armistice 229 X. Operations of the Reichsbank during the War 266 XI. Operations of the Reichsbank after the Armistice 267 XII. Exchange Rates in New York on Belligerent Powers during the War 310 XIII. Exchange Rates in New York on formerly Belligerent Powers after the War 311 XIV. Exchange Rates in New York on Neutral Powers during the War 316 XV. Exchange Rates in New York on formerly Neutral Powers after the War 317 XVI. Exchange Rates in Switzerland on Berlin and Vienna 1914- 1918 32r XVII. Exchange Rates in New York on Silver Standard Countries during the War 325 XVIII. Exchange Rates in New York on Silver Standard Countries after the War 326 XIX. Exchange Rates in New York on Balkan Countries after the War 327 XX, Exchange Rates in New York on New Countries after the War 328 XXI. Relation Between the Fall in Exchange and the Rise in Prices 340 XXII. Relation Between the Depreciation of Exchange and Depre- ciation of Currency, , , , , 341 xxxiu Digitized by Microsoft® Digitized by Microsoft® POSTSCRIPT Before the war, the world functioned as an economic unit, as a single organism. During the war, it was fractured, economically. Both groups of belligerents and the overseas neutrals constituted three practically separate economic systems. At the same time, debts were greatly increased and paper money was printed in huge volume. Since the war, the return of prewar conditions of economic interdependence and of stable currencies has been obstructed by the terms of the peace. And therefore the world suffers. Upon what sort of world did the Great War break? Essen- tially it was a mobile world, an organic world. The world in 1914, as distinguished from previous periods of great wars, was highly interdependent. Transportation and communication on land, over and under the sea and in the air, by steam power, electricity and motor oil, knit together the uttermost ends of the earth. News was simultaneously published in distant lands. An insect pest, the wheat rust or the boll weevil, was no longer merely of local concern; on the contrary human beings in foreign parts were deprived of food and raiment. Densely settled Europe became the workshop of the world. It exported finished goods to overseas regions, and imported food and raw materials. The competition of manufacturing countries led to the search for new markets and for new sources of supply of raw materials. And out of this seeking resulted the colonial expansion of the European powers, the building of new railroads, the investment of foreign capital to open up the world's wilder- nesses, which were to furnish both more raw materials and more markets. Trade was fairly unrestricted. The little nations, Switzer- land, Holland and Belgium, did an extensive transshipment trade for the great powers. The great manufacturing nations were each Digitized by Microsoft® XXXVl POSTSCRIPT Other's important customers. The exploitation of raw materials was not nationalized. Great Britain controlled the world's supply of oil-seeds but a small German city, Harburg, was the center of the oil-seed crushing industry. The United States was the lead- ing source of cotton and of copper, but England and Germany were the chief makers of textile and electrical goods for domestic and foreign markets. Germany, as a result of her system of education, developed those industries which required a wide diffusion of sci- entific knowledge, and which held the key to the economic life of the nations, such as the manufacture of drugs, dyes, optical goods and electrical machinery. The world had become dependent on Germany for many of its "key industry" products. Before the Great War, the world had become unified, inter- dependent, organic, sensitive. Therefore, men were encouraged to dream of universal peace, and therefore, also, had war become so costly, both in money and in sacrifice. In fact, Achille Loria, the Italian economist, pointed out that the greater cost of modern war promises to widen the "zone of arbitration" ; when nations risk in war more than they are likely to gain as a result of it, peaceful settlement becomes profitable. Then came the great catastrophe. Economically, it revealed to the world the essential dependence of each people upon all others. The harmonious functioning of modern industrial society was possible only within narrow limits and under conditions of peace. The suffering during war time resulted from an attempt at self-sufficiency, enforced upon the nations, belligerent and neutral. An international-mindedness has grown out of the war. Not only the London merchant, but also the tin miner of the Straits Settlements, the coffee laborer of the Brazilian plantations, the toiler in the Congo rubber fields, and the Afghan tribesman, had been economically knit to overseas communities before the war. The great cataclysm shook them profoundly, and left them more conscious than before of their dependence on other human beings in distant lands. The war in Europe incited mobs to rice riots in Japan, and to race riots in our own East St. Louis. It raised the cost of living in China and caused strikes in Argentina. To predicate isolation of any country, even of the United States, is an exhibition of infantile and wishful thinking, — the desire to escape from the responsibilities of reality. The belligerent nations sought to increase their supplies for Digitized by Microsoft® POSTSCRIPT XXXVU war purposes. But they did not realize adequately the nature of the industrial readjustment demanded by war, the need for the repression of luxury consumption and of non-essential production, nor did they frame a fiscal policy that would obtain this result. Excepting Great Britain, which relied heavily on taxation, the European powers financed the war chiefly by means of loans and paper money, put the burden during the war upon the weaicest shoulders in the community, and embarrassed the finances of the postwar period. The war has made the masses conscious of the vital bearing on their lives of their government's policies in finance, matters generally regarded of recondite nature and remote inter- est. The vanishing of lifelong savings, stolen by the state through inflation of the currency, the tantalizing rise in the cost of living of the poor, and the under-nourishment of their children has made the public appreciate the significance of public finance to private welfare, and the costliness of invisible taxation. The pursuit of seemingly painless policies in finance are now ending in the per- plexities if not the despair of ministers of finance, and in the trials if not the tragedies of millions of human beings. The postwar difficulties arise from the efEects of the war, and of the terms of the peace. The financing of the war by loans and paper money resulted in huge debts, inflated note issues, de- preciated currencies, gold embargoes and unstable exchange rates. These largely inevitable postwar conditions repressed production and hampered international trade, but in addition the terms of peace played havoc with the prewar economic organization of Europe. As if the war had not bequeathed a sufficient heritage of woe, the peace conferees bestowed upon Europe new difficulties of their own creation. Like the Bolshevists who think that the economic life of a nation will function under all conditions, just because it happened to function under certain known conditions, the peace makers at Paris took for granted that Europe would thrive because of many restrictions, just because it flourished in spite of a few of them before the war. It is unnecessary to recite in detail the much criticized and now well-known errors of the diplomats at Paris. Map making, rather than healing of the economic wounds of Europe, was their main concern. They drew boundary lines instead of reviving in- dustries. The British statesmen did not maintain the same dis- passionate attitude toward Germany in 191 9 that their predecessors Digitized by Microsoft® xxxvm posTSCsiPX did toward France in 1815. No Allied statesman in 1919 had the vision to foresee the chaos that now grips a disintegrated Europe, and none had the courage to face the mob spirit, rife after the armistice. The European diplomats were the victims of the propa- ganda which they had engendered and supinely they fed the hate and passion which they had aroused. None uttered words, such as Castlereagh wrote to Wellington in 1815. "There is not a power that borders on France, from the Channel to the Medi- terranean, that is not pushing some acquisition under the plea of security and rectification of frontier. They are foolish enough to suppose that the Great Powers are to be in readiness to protect them in the enjoyment of these petty spoils." Professing the ideal of self-determination, but practising the ruse de guerre of debilitating the enemy powers, the Allied diplo- mats cut up Central Europe. The existing systems of transporta- tion were rendered ineffective by the new boundaries, and the newly created states must therefore dissipate their energy, construct- ing new railroads for a new industrial society, establishing new mints, new banks of issue, new post offices, new bureaucracies, and new overhead charges for new states. New tariffs and new re- strictions on trade were enacted. The economy of large units had been applied in industry during the war, but was ignored in state- making at the peace table. In the words of Brailsford's "After the Peace," "The treaty worked against life, against creation, against production. It crushed the most productive people, for^ getting that production carried to the utmost level attained in Central Europe can be the effort only of generations of education, science and organization. It showered its favors on Poles, Ru- manians and Jugoslavs, primitive, unschooled races, not indeed without their own charm and emotional genius, who never, even after generations of experience, are likely to replace the Germans as industrial or intellectual workers." To cap the climax, and in spite of the dictates of prudence and of their plighted word at the armistice not to include pensions and allowances, the Allies levied an indemnity on the defeated powers, which, because of its amount, has completed the task of disorganizing the prewar economic system of Central Europe. In the words of one of the legal counsel of the American peace dele- gation, they worked on the theory that "a hurricane from the west might repair the damage wrought by a hurricane from the east." Digitized by Microsoft® POSTSCRIPT XXXIX Then, lite Goethe's Zauberlehrling, who conjured up the spirits but could not lay them, the Supreme Economic Council, in its statement of March 8, 1920, essayed to find a magic formula that might undo the mischief wrought by the fatal words of the treaty. After having sown the seeds of another war in Europe, the Supreme Economic Council exhorted the new states to cease fight- ing. After pulverizing the Central European bloc, the Covmcil urged the constituent parts to form a new economic unit. After letting loose the nationalist passions, the Council vainly pleaded to restrain their expression. What of the outlook? Financially, the governments of Europe present an array of pathological cases, from Russia, Poland, Austria, and recently Germany, whose currencies are almost worth- less, on the one hand, to Italy, France, and Belgium and so on up to England, whose exchange rate is depreciated relatively least among the great powers of Europe. The entire gamut of financial disorders is here presented. The currency of the first group of countries will never return to gold parity, that of England most likely will, barring unforeseen contingencies. Whether the paper money of the members of the intermediate group will again equal gold parity is an open question. If they deflate their currencies, the burden of the debt charges may bankrupt them. There were budget deficits in three-quarters of the countries represented at the International Financial Conference at Brussels in 1920 and in eleven-twelfths of the countries of Europe^ and there is little like- lihood of an improvement in the near future. Twenty per cent on the average, and in some cases much more of the budget ex- penses of the powers represented at the Brussels conference, were devoted to armament and military operations. Militarism has be- come a luxury that present-day Europe cannot afford. From the point of view of the continued existence of the European states, and of the survival of their inhabitants, fighting is a non-essential industry. The price of imperialism has exceeded the capacity of the peoples to pay for it. The treaty may be unjust in its principles, and unsound in its prescriptions, yet the solution of the difficulties in Europe lies not in another military conflict. Civilization dare not soon again be fluxed in the crucible of war. The slower processes of interna- tional adjustment by negotiation seem the alternative means to attain stability in Europe. Time is the ally of truth. A growing Digitized by Microsoft® xl POSTSCRIPT international public opinion will not long brook injustice, be it in Korea or Colombia, in Shantung or Silesia. And to this delib- erative process of modifying the recent treaties, and of readjusting international relations, America can not be indifferent. America is deeply concerned in the remedies to be applied. She is tied to Europe by innumerable bonds, political nerves, and economic arteries, and the paralysis of the peoples in Europe is reflected in the unhealthy condition of the United States. The symptoms of disorder in our own country are traceable to the focus of infection in Europe. That the world is a living, organic unit is painfully brought home to the nation which, according to some of its spokesmen, pretended to live in isolation. In some of the steps to be taken to insure the recovery of the nations of Europe, foreign influences avail little. These nations must, themselves alone, grapple with many problems: deflation, balancing of the budget, stabilization of note issues and of the purchasing power of paper monies; ultimately perhaps a revalua- tion of the currency and the free movement of gold ; the funding of floating debts; the conversion of existing debts into issues bear- ing a lower rate of interest; in some countries a capital levy; in others a forced loan, and perhaps in a few, bankruptcy and a dean slate — these financial travails must be borne by each nation for itself. Only in measures of international concern can America lend any aid. She can encourage international loans by joining, in the definition of her own claims against the Allies, and in the de- termination of questions of security and priority of new private loans. She can put the credit facilities of New York at the dis- posal of borrowers whom London alone can no longer accommo- date. She can advocate the further moderation of the terms of the treaty, a policy hitherto pressed chiefly by Great Britain alone. America can exert her influence to eliminate trade restrictions, and to strengthen those forces making for economic unity and the harmonious functioning of the nations of Europe. But no ipse dixit of any single power will produce an adequate result. Alone, America may preach and pray, but she can neither direct nor govern in international affairs. Her vast Interests within her own boundaries and her relatively sparse population have prevented the development of a decisive interest and effective public opinion in international problems, or of a personnel trained in foreign Digitized by Microsoft® POSTSCRIPT xli affairs. The assets of America in the council of the nations are an economic disinterestedness and the capacity for a moral enthu- siasm, such as its people evinced during the war. Unexpressed, her disinterestedness must degenerate into indifference, and her generous cooperation in wartime cool to cynical apathy. Within an organization of the nations, her attributes may be effective in the redemption of Europe. Without membership in an interna- tional body, America's efforts have been halting and half-hearted, and her potentialities for service to the world and not less to herself may eventually wane. In the reorganization of international finance, America can function more worthily and effectively in conjunction with the other powers, both those in distress and those capable of aiding. The promotion by the United States of closer international bonds does not imply the assumption of other nations' burdens. The exercise of the influence of the United States in international affairs does not involve a guaranty to foreign countries against the losses resulting from unsound fiscal policies, or a willingness to underwrite the inept war financing of certain of the European powers, or a readiness to make good out of its resources the in- dustrial losses to Europe resulting from unworkable reparations terms. This generation of Americans has a plain obligation to the world, and to itself. History will judge our heads and our hearts, our sagacity and our altruism by our present foreign policy. Digitized by Microsoft® Digitized by Microsoft® INTERNATIONAL FINANCE AND ITS REORGANIZATION Digitized by Microsoft® Digitized by Microsoft® International Finance and its Reorganization SECTION A THE EFFECTS OF THE WAR Digitized by Microsoft® Digitized by Microsoft® INTERNATIONAL FINANCE AND ITS REORGANIZATION Part One PUBLIC DEBT AND TAXATION CHAPTER I PRINCIPLES AND PRACTICE IN THE WORLD WAR^ A. The Theory of War Finance A mediaeval method of financing war was by means of a fund accumulated as a measure of preparation. A militaristic method of financing war was the seizure of booty, levying upon the invaded territory, and the imposition of indemnities. In modern times nations have financed military operations by means of paper money. More recently the chief reliance has been upon loans. The demo- cratic way of financing a war is to impose heavy taxes and to raise the balance of necessary revenue by loans. In times of peace the social surplus is the difference between the goods consumed in maintaining life and the goods produced in industry. Theoretically, the entire social surplus may be appro- priated temporarily for the public need by taxation. The objective costs of war are goods and services, devoted to the conduct of mili- * Patten, Simon N., Mandeville in the Twentieth Century. American Economic Review, March, 1918. Kemmerer, E. W., Inflation. American Economic Review, June, 1918. Seligman, E. R. A., Who is the Twentieth Century Mandeville, Ibid. Plehn, Carl C, Substance and Shadow in War Finance, Idem., Sept,, 1918. Davenport, H. J., The War Tax Paradox, Idem., March, 1919. Papers by Adams, T. S. ; Hollander, Jacob H. ; Patten, Simon N.; Seligman, E. R. A. ; Sprague, O. M. W. ; and others. The Annals of the American Academy of Political and Social Science, January, 191S. Sprague, O. Mi W., The Conscription of Income, Ecoiidmic Journal, March, 1917. Digitized by Microsoft® 2 INTERNATIONAL FINANCE AND ITS REORGANIZATION tary operations. The subjective costs of war are burdens and sacrifices made by the community in effecting a transition from peace to war. The burden of war falls on the fighting generation, for it must reduce its consumption by an amount equal to the m- creased military consumption and the capital invested in war plants and facilities. The demand of the fighting generation on the current national income must be reduced by deferring satis- factions or by lowering the standard of living. The contribution of goods for the conduct of war must come out of current production. The past can contribute but little, for fixed assets and capital goods cannot be consumed, except to a slight extent. But the future contributes nothing at all, for goods to be produced after the war cannot be used during the war. Furthermore, a fighting nation may increase its consumption, if another nation is willing to lend its current surplus of production. The goods are provided during the war. "The future does not provide for the war; future producers merely indemnify present providers. The lending nation or persons who bear the burden during the war may be indemnified later at the cost of other people." The real cost of the war can be met only by a reduction in consumption. A country with an annual surplus of $i ,000,000,000 cannot spend $5,000,000,000, unless it borrows abroad or inflates its currency. No nation can spend more than it can produce and borrow. And the advocates of light taxation and large loans stultify themselves, when they point out the discrepancy between the amounts to be raised by loans and the amounts available from taxation. Curtailment of consumption may be effected in three ways. Taxation involves a compulsory decrease in consumption. Withers, Hartley, Our Money and the State, p. 29. Pigou, A. C, The Economy and Finance of the War, 1916, p. 7a Joint Conference of the Western Economic Society and the City Club of Chicago, June 21, 22, 1917. Financial Mobilization for War. Proceedings of the Twenty-ninth Annual Meeting of the American Economic Association, December, i9i£. Scott, W. R., The Adjustment of War Expenditure between Taxes and Loans. Glasgow, 1917. Edgeworth, F. Y., Currency and Finance in Time of War. Oxford, 1917. Arbuthnot, C. C, Paying the Cost of the War. The Scientific Monthly, voli vii: 413-434. Laughlin, J. Laurence, Credit of the Nations. Scribners, 1919, Chap. II, War and Credit. Digitized by Microsoft® PRINCIPLES AKD PRACTICE IN THE WORLD WAS 3 Appeals to buy bonds lead to voluntary curtailment of consumption. And finally, inflating the currency reduces purchasing power and by stealth deprives the masses of the ability to buy. Taxation means relatively low net money wages and relatively stable prices. Inflation means an increase of money wages but a decrease in real wages because of a relatively greater rise in commodity prices. In any event, the consumption of the masses is restricted, so that the non-prodqcers and fighters may be maintained. To increase the margin between consumption and production there must be either a lower money income per capita or less purchasing power in the unit of money. i. Goods versus Credit An adequate comprehension of war financing requires that symbols and tokens of value, such as money, currency, and credit be left out of consideration and that the underlying production, consumption, and surplus of economic goods be studied. In times of peace the consumption of goods is limited by produc- tion and distribution. There is always the underfed group at the margin of society. In times of war the production and distribution of goods are conditioned by war requirements or consumption. Plants are built to meet needs.^ The increased consumption of goods in time of war is not so great as it seems, for the increase in public consumption is balanced by the restriction of private consumption. A mobilized army con- sumes to a large extent much the same quantity of food and clothing as its members consume in times of peace, and the increased con- sumption of strictly military goods is made possible by the restriction on the production of goods not essential to the conduct of the war. The emphasis on the concept of goods rather than of money helps to clarify thinking. The need for the economic readjustment incident to the beginning and the ending of a war becomes evident. Furthermore, it becomes clear that the generation that conducts the war must pay the whole cost of the war, and that the burden cannot be shifted to the next generation.^ "Adams, H. C, Public Debts. D. Appleton & Co., 1887. Chapter on Financial Management of the War. Pp. 105-142. ' Report of Committee on the Purchasing Power of Money. American Economic Review, vol. IX, No. i, supplement, p. 365. Digitized by Microsoft® 4 INTERNATIONAL FINANCE AND ITS REORGANIZATION "For each generation must subsist upon the products of its own industry. No father can eat the potatoes to be hoed by an unborn son, nor can an army live on bread to be delivered betw^een ten and forty years from the date of the contract." * Furthermore, this distinction betw^een goods and credit makes it possible to distinguish between the actual vi'ar losses and the so-called war costs. The war losses are in goods and the war costs are expressed in terms of money. Losses include goods that were destroyed. Costs include (i) a national debt which has become the private assets of the nation's citizens, (2) paper currency, which was issued to buy goods, and (3) taxes, which represent a part of the private surplus surrendered to make possible an increase of public consumption.^ It is evident then that goods are primary and that credit and money, which are merely measures of goods, are secondary. Although goods are consumed or destroyed, the money paid for them remains. It is not liquidated. The lender furnishes present goods and the borrower promises to repay future goods. The wastes of war consist of the destruction of surplus goods. To make the surplus as large as possible, consumption of non-essential goods is curtailed so that the production of essential goods may be increased. But at bottom the waste resulting from war is the same as the waste resulting from extravagance in times of peace. Both are alike in that they result in the depletion of the economic surplus. The failure to satisfy the demand for luxuries is a phase of the diverting and deferring of human satisfactions in order to promote the war aims or to meet the pressing social need. Credit, however, depends upon goods. The ability to borrow depends on the productive power of a nation, present or prospective. Banknotes and paper money do not increase a nation's wealth. Furthermore, great debts do not end a war. As the surplus of production over consumption is reduced, a nation is weakened. When the surplus above the necessities is wiped out, the war must cease. National exhaustion is reached not when the debt reaches a certain limit (as Karl Helflerich thought would be the case when Germany's debt reached mk. 100,000,000,000) , but when the mar- gin of production over consumption becomes a minus quantity. This •Adams, H. C, Ibid. ' Jaffe, Edgar, Kriegskosten und Volksvermoegen. Europaeische Staats- und-WirtschaftB Zeitung, December 15, 1917. Digitized by Microsoft® PRENCrPLES AND PRACTICE IN THE WORLD WAR 5 margin is fixed not alone by the increase in production of essential goods, but by decrease in the consuniption. This second factor particularly is elastic. In 191 5 the Germans raised the cry that the nation was being starved, and yet for three years longer they conducted a war which exhausted their European opponents and which was finally decided only when the latter obtained uncon- ditional access to the supply of goods made available in the United States. This restriction of consumption of goods in Germany HelfEerich termed "the moral reserves" of the German people. ii. Inflation (a) Causes of Inflation — In normal times the banking practice of most countries imposed a limit on the volume of notes and deposits with respect to the gold reserve of the state bank. As a result of war, this limit was suspended. The banks lend to the government, which receives a deposit credit, and against it payments are made to the w^ar indus- tries, whose deposits in turn are increased. The inflation finally filters throughout the community. In time of war the govern- ment has enormous purchasing power. It needs goods and bids up prices. There is little difference whether the increased pur- chasing power of the government takes the form of deposit credit or paper money. To the extent that loans come not from savings of the investor, but from his borrowings at the banks or from sub- scription by banks, inflation is caused. The increase in deposits causes an increased demand for small currency and paper money to transact business. This currency is usually inconvertible so that while there is no danger of a run on a bank, there is also absent the wholesome check upon the excessive issue of paper. In brief, the rise of prices during a war is caused by the large and pressing demands of the government and an increased supply of credit or currency. (b) The Nature of Inflation — Inflation results from a lowering of the ratio of the volume of goods to the volume of money. If the volume of money in circulation increases more rapidly than the volume of goods pro- duced, prices will rise. This is an historic process. Professor Thorold Rogers in his "History of Agriculture and Prices in Digitized by Microsoft® 6 INTERNATIONAL FINANCE AND ITS REORGANIZATION England" shows that in the thirteenth century an ox was worth about los., a sheep is. 6d., and a quarter of wheat 5s. 6d., and the wage of a laborer was about sd. to 6d. per day. About the year 1500, an ox cost 22s. 6d., a sheep 2s. 4d., a quarter of wheat 5s. 6d., and the wage of a laborer about 5d. to 6d. per day. Average decennial prices of oxen from the thirteenth to the seventeenth century are given herewith:* Period Average price o£ oxen s. d. 1261-1270 '° 3, 1331-1340 12 9i 1391-1400 14 9I 1461-1470 20 7I 1521-1530 30 io| 1571-1580 8s loi 1633-1642 189 8 1693-1702 166 8 When the increase in the volume of gold or of credit or in the circulation of money outruns the increase in production of goods, prices rise. (c) The Results and Evils of Inflation — Inflation results in a rise in prices or a decline in real wages. As a result of competition between employers, money wages tend to rise after prices, but they lag behind. The lag of wages and of other costs of production behind prices makes profiteering possible. When profits are made at the expense of wages it means that the laborer bears the brunt of the war and the profiteer fixes his gains by investing them in war loans. The laborer's invisible contribu- tion to the war consists in the amount by which wages lag behind prices. The burden of the war, therefore, falls upon a class least able to bear it. Income is shifted from the thrifty wage earner to the spendthrift profiteer. Inflation is an unrecognized form of taxation, which falls upon those with fixed incomes from labor or investments. Inflation constitutes an income tax on the salaried class and a capital tax on the bond owner. • Rogers, J. E., Thorold, History of Agriculture and Prices in England, Clarendon Press, 1866-1902, vol. I, p. 361, vol. IV, p. 355, vol, V, p. 354. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 7 Another evil of inflation consists in the fact that the govern- ment receives money of a low purchasing power during the war and later retires its bonds with money of a high purchasing power, although as an offset the government is usually able to refund at a lower rate of interest. Since the postwar taxes do not fall on the holders of government bonds pro rata, the war profiteers are favored. Again, the increase in deposits and in banking trans- actions creates a false optimism, which operates against economy in the use of funds. Finally, inflation frequently results in a departure from the gold standard, a dislocation of international trade, depreciation of the exchanges abroad and a discount on paper money at home, and a diiBculty in contracting foreign loans. However, inflation does play a useful part in several ways. Primarily, it results in a rise of prices which stimulates industry. Financially it has the value of a bundle of hay tied in front of a donkey's nose. The tremendous increase in production in the belligerent countries during the war was partly the result of war- time inflation. On the other hand this benefit is limited to the early stages of the war, until the maximum of productive capacity is developed. Inflation is indiscriminate in it effects, and the non- essential industries as well as the war industries are stimulated. Finally, inflation compels economy and a reduction in the con- sumption of luxuries, thus releasing labor and capital for the pro- duction of essential goods. However, this end may be attained more directly by taxation, by rationing raw material, or by establish- ing priority in shipment or in financing. iii. The Burden of the Present or the Future Generation Though it is true that the war-waging generation must provide the goods, the burden falls upon the individuals of future genera- tions to the extent that the taxpaying and the bondholding groups are not identical and that the expense of collection of taxes bears on these later generations. While the country as a whole is neither richer nor poorer, after it has returned as bond interest the taxes which it has collected for this purpose, there is a transfer of wealth from one group in the community to another because the proportion of taxes paid by the various classes of income-taxpayers does not correspond with the proportion of war-loan interest received by them. The individual who was enriched as a result of the war Digitized by Microsoft® 8 INTERNATIONAL FINANCE AND ITS REORGANIZATION and who may have bought war loans is benefited in the after-war period. On the other hand, the individual or corporation which is developing a profitable business in the after-war period bears the burden. Taxes to pay interest on war loans hamper produc- tion and repress industry after the war. In other words, the greater the reliance upon loans for financing a war, the greater the likelihood of shifting wealth among the individuals of later genera- tions, often unjustly and often to the detriment of the industrial development of the country. To the extent that the war is financed by taxes, the burden is borne by the generation that fights. The accounts of future gen- erations remain unaffected except to the extent that overwork or undernourishment may impair the post-war productivity of the war- waging generation and the vitality of succeeding generations. The financing of war by loans tends to fix the riches of the class that profited most through the war, and to transfer the tax burden to the less fortunate individuals of succeeding generations. On the other hand, the financing of war through taxation confines the burden to the war-waging generation. Again, severe taxes during war are temporary in their nature and do not repress production as much as prolonged heavy taxation in the after-war period. In brief, financing a war by taxation leaves less of a burden upon the individuals of later generations than does financing by loans.^ iv. Taxes vs. Loans In considering the alternative of taxes or loans, there are other aspects than the burden on the individuals of the war-waging or subsequent generations. The question as to whether a war should be financed entirely by loans, entirely by taxes, or by a combination of both of these methods has been repeatedly discussed by economists and treasury officials in recent times. Taxes involve compulsory saving, but loans voluntary saving. A forced loan also compels saving, but is less likely to lead to evasion than taxes. "Taxes and bonds, so far as they are paid by income receivers out of income receipts, are merely different ways of getting the paying done, so that war activities and war consumption may displace civil activities and civil consumption, 'Pigou, A. C, The Burden of War on Future Generations, Quarterly Journal of Economics, Feb., 1919, vol. 33, pp. 342-255. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORID WAR Q and not at all a way of deciding whether the paying shall be done now. With taxes, the contributions are collected, the tale is told, the books closed. The loan method provides that tax payments shall be postponed, not that payment be postponed; that future taxpayers shall indemnify the lenders for their present advances; not that the future shall provide the ships, the coal, the shells, the clothing, the cannon, the food, but that the present furnishers shall in the future be reimbursed through taxes for what they have now advanced. The taxpayer of the future time will merely return to the present contributors (with the addition of interest, it is true) what present taxation would have compelled them to pay now. Taxes are merely postponed and somewhat increased. But the present does not get rid of the burden. The present taxpayer gets rid of it now, only in the sense that the present bond buyer temporarily assumes it. The bond method means merely present sacrifices out of present incomes in support of the present war on terms of a promised later indemnity out of taxes later to be collected. The tax method means contributions without a promised indem- nity." » (a) Loans — It may appear that the alternative of loans or taxes really does not exist; that all funds ultimately come from revenue and that therefore the liquidation of loans involves taxation ultimately. But the fact is that the severity of taxation during a war is a determin- ing element, for the liquidation of war loans may be brought about by much lighter taxation spread over a period of years. Further- more, it has been held that production during a war should not be repressed by heavy taxation. Again, since war is an extra- ordinary expenditure, it is held to be unwise to attempt to make the ordinary revenue cover it. Finally, no scheme of taxation can be just to all the members of a community. A mild levy may be inequitable but tolerable; a very heavy tax may not only work an intolerable injustice, but it may even prevent its own operation. On the other hand, loans undoubtedly lead to inflation. For to the extent that there is a liquid surplus, it may be taken by taxes ; therefore loans must be raised, in large part at least, by borrowing at the banks, and thus they inevitably lead to inflation. 'Davenport, H. J., ibid. Digitized by Microsoft® 10 INTERNATIONAL FINANCE AND ITS REORGANIZATION I, The argument for bonds — Because loans lead to inflation and raise prices, production is increased during the war and there- fore there is a larger surplus of production over consumption avail- able for the emergency. Taxes have no such effect. Furthermore, loans at the beginning of a war are necessary in order to give the tax payer time to adjust himself to new burdens and to give the war plants ample funds for prompt expansion. No one now advocates the financing of a war entirely by loans. The use of credit in part is defensible, if post-war taxation to pay ' interest and principal does not throw the burden upon the poor, those that could not buy war bonds. There have been, however, faulty arguments in favor of the use of war loans. Some economists hold that regularly recurrent expenses should be met out of taxation, but that emergency or war needs may properly be met out of loans, provided they are repaid before another similar emergency is likely to arise. The fallacy of this argument consists in the fact that borrowings by a corpora- tion or by an individual are different from the borrowing by an entire community of itself. The borrowing individual or corpora- tion obtains the accumulated surplus of others. The same is true in the case of an external loan to a nation. But the state borrow- ing internally must rely upon the increase of its surplus of produc- tion over consumption. Another faulty argument in favor of loans is that they do not cause greater inflation than taxes. The theory is that inflation is caused by the increased demands of the government, the dislocation of production and the increase in private credit and in the currency. However, this conclusion takes no account of the fact that the increased supply of currency is in part the result of the loan policy. The Bank of France issued notes against government securities. The Bank of England increased its "public deposits" and ultimately "other deposits" against government advances. In the United States and in the other belligerent countries, the holders of war paper were given preference in making loans at the banks, and thereby deposits, merely another form of money, were increased. For a government bond is good collateral at the bank, but a tax receipt is not. While it is true that taxpayers have to borrow at the bank to meet their assessments, yet such borrowings are neces- sarily both brief and self-liquidating, but borrowings on war paper are neither. Furthermore, if tax installments were broken up into Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR II smaller fractions, the need for borrowing could be obviated. Great Britain, for example, permitted the artisan to pay his taxes in weekly installments. 2. The argument against bonds — ^The chief argument against bonds as a means of financing a war is the growth of infla- tion. If the public bought the entire loan inflation would not follow, but it is because the banks must carry a large part of the bonds for the subscribers and for themselves that the disadvantages of the loan method come about. Loans lead to an increase in government expenditure without correspondingly curtailing private expenditure, as taxes do. Prices must therefore rise. Whereas taxes may cause some inflation, it is incomparable in extent to the inflation caused by the loan policy. "Bonding induces people to think they can grow rich on the unproductive expenditures of the state. Consumption is expanded when it should be contracted. A shortage of goods follows and then come high prices, which make people believe they are more prosperous instead of less so. Taxation if wisely laid would bring order out of chaos and not only exempt future generations from the burdens of war but also lighten those of the present. In essence, the burden of the war is the excess of national expenditures over national surplus. To this amount the consumption of the people must be reduced. If expenditures are seven billion dollars, consumption should be reduced by this amount and the saving turned over to the government. The account is thus squared in each year and the war is paid for but once. . . . Advocates of the loan policy think it suicidal to take seven billions directly and yet the policy adopted takes double the amount from the people's pockets. . . . This shows that the people are paying two dollars in increased prices for every dollar the government benefits by loans. The high prices make profits and the govern- ment borrows the net gains of the profiteer to carry on the war. Forced saving by this process turns over a part of the people's daily consumption to the recipients of high prices. What the people save is thus given to a privileged class and they loan it to the government. . . . This is the essence of carrying on the war by means of loans. The people pay for the war by their reduced con- sumption, the benefit of which goes to the profiteer. . . . War loans are war profits. ... If the high prices were occasioned by an increase of paper money, the advocates of it would have to Digitized by Microsoft® 12 INTERNATIONAL FINANCE AND ITS REORGANIZATION blush for their logic, but when the same inflation is produced by a bond issue a quibble is possible which permits a flood of new argumentation over a point long ago settled. "The people suffer from inflation and thus pay for the war; they will suffer and pay again when the bonds are redeemed. And there will come the greatest suffering of all in the financial crises which bring inflated values back to a normal basis. Three pay- ments and perhaps more are what this financial method imposes. . . . We spend money but instead of recognizing it we cover it up by calling our liabilities assets. To tax the nation ten billions does not differ in its ultimate effects on wealth from a bond issue to a like amount. In either case we are ten billions poorer. In one case we see it and adjust our expenses accordingly, in the Other we rush on into new extravagances. A risk is run for which there is no compensation." * "Under the tax method the rich and moderately rich really shoulder the whole burden of the charge that is laid upon them. Under the loan method they do not do this, because they are compensated afterwards through taxes laid for that purpose, partly on themselves, but partly on other and poorer sections of the community." " "Prophetic foreboding that labor, having paid once for the war, must now pay a second time to those lending for the war, is in the fatal way of fulfilment. The bonds that had been purchased out of the margins contributed by labor become a valid obligation against the laborer as taxpayer." ^^ Such are the views of the advocates of financing a war entirely by taxation. 3. Effects of loan policy in war of 1812 — During the World War the policy of relying on loans has had very unfavor- able after-war effects in Italy, Germany and France. Indeed, few wars of history have been financed exclusively by loans. In American history an excellent illustration of the failure of the loan policy may be found in the financing of the War of 1812. In his report for the years 1808 and 1809, and in subsequent papers, Secretary Gallatin gave it as his policy that "no internal •Patten, S. N., ibid. "Pigou, A. C, ibid. " Davenport, H. J., ibid. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR I3 taxes either direct or indirect are contemplated. • . . Loans reim- bursable after the return of peace, must constitute the principal resources for defraying the extraordinary expenses of the war, . . . So long as the public credit is preserved and a sufficient revenue is provided, no doubts are entertained of the possibility of pro- curing, on loan, the sums wanted to defray the extraordinary expenses of a war. ... In proportion as the ability to borrow is diminished, the necessity of resorting to taxation is increased." ^^ The results of the loan policy were well nigh disastrous. The amounts talcen by the public declined as successive loans were put out and the cash realized grew ever smaller, part of the fourth loan being put out at from 65 per cent to 69 per cent of the par value. Furthermore, when the public would no longer take govern- ment bonds, treasury notes were put out in increasing amounts and these too were issued at ever lower prices or at decreasing jrields. The failure of this policy became most evident when there was subscribed only about $750,000 of the balance of over $12,- 000,000 authorized by the Act of March 24, 181 4. The loan policy of Gallatin was opposed by the advocates of a limited taxation policy. The chairman of the Committee of Ways and Means, Mr. Bacon, foresaw at the very beginning of the war the inherent difficulties of the loan policy. He said, "If we yield to the new theory of borrowing both principal and interest, we have no data by which to judge upon what probable terms loans may be obtained at all, or how long it will be before we must wind up business." ^^ The acting Secretary of the Treasury, Mr. Jones, advocated war taxes primarily to support the loan policy of the government, and said, "As reliance must be had upon a loan for the war expenses of the year 1814, the laying of the internal taxes may be considered, with a view to that object, as essentially necessary ; in the first place to facilitate the obtaining of the loan ; and secondly for procuring it on favorable terms." " Finally, Gallatin's successor, Dallas, pointed out that "the plan of finance which was predicated upon the theory of defraying the extraordinary loan expenses of the war by successive loans, had "Adams, H. C, Life of Gallatin, and other sources quoted in Public Debts, ibid. "Annals of Congress. 12th Con., 1st sess., col. 1098, quoted by. Adams, ibid. "Annals of Congress. 12th Con., and sess., col. 896, Digitized by Microsoft® 14 INTERNATIONAL FINANCE AND ITS REORGANIZATION already become inoperative, . . . owing to the inadequacy of our system of taxation to form a foundation of public credit. The financial record of the War of i8i2 shows the weakness of the policy of raising money by loans exclusively. It resulted in a decline of the national credit, in a deficit in the last quarter of 1 8 14, and in the abandonment of the policy in the midst of the war. (b) Taxation — 1. The ARGUMENT FOR TAXES — Several economists both in Great Britain and in the United States, advocated that the war should be financed mainly if not entirely from the proceeds of taxes. Taxes curtail the spending power of the community and therefore create less inflation. Furthermore, the curtailment by legislation of civilian demand and of luxury expenditures releases funds for taxation and simultaneously compels conversion of plants to war uses. While the total output during the war is greater than during peace, yet essential industries usually suffer for lack of labor and material because spending power is not sufficiently curtailed by taxes. Taxes hasten military preparation. Heavy war taxes are a lighter burden than they seem because of the war psychology and of the devotion to the nation's interest. Wages and profits in many industries are high and the profit motive is replaced by national motives. Furthermore, the limita- tion on the investment of capital makes it possible for the state to takp an unusually large percentage of the surplus for current con- sumption. During a war state control prevents the escape of taxable capital from the country. Low taxes during the war mean high taxes after the war when the reconstruction needs of countries are great. Finally, in a period of inflation taxes, based on ability to pay, are easily borne. If they are not levied during the war, taxes imposed later to meet the interest on bonds bear heavily upon the community during a period of deflation when the taxpayer turns over to the bondholder a dollar of larger purchasing power than that loaned. War loans involve a redistribution of wealth ^ after the war in favor of the war profiteer. 2. The ARGUMENT AGAINST TAXES — ^Thc arguments against very heavy taxation are both theoretical and practical. A very "Life and Writings of Dallas. Quoted in Adams, ihid. Digitized by Microsoft® PEINCIPLES AND PRACTICE IN THE WORLD WAR I J heavy tax would compel borrowing and thus lead to some inflation. To the extent that these borrowings exceed the normal borrowings in time of peace, inflation must result." Furthermore, heavy taxes on business enterprises during the war may at the very moment when maximum output is needed repress production and thus reduce rather than enlarge the social surplus. Excessive taxes may injuriously lower the standard of living and may dry up the sources of funds for the support of social activities not recognized by the state. High taxes which would seriously curtail consump- tion might create resentment and opposition on the part of the community and break the morale needed for victory, even though a similar or greater burden resulting from rising prices would be accepted with resignation. Inflation is a financial anesthetic which makes the pain of reducing one's purchasing power tolerable. High taxes demand the fortitude of the old-fashioned surgical operations. But the chief objection to an all-tax policy is the matter of administration. Heavy taxes would involve industrial chaos and even bankruptcy, so that the receipts from taxation in practice would be far less than the estimates. Furthermore, a program of taxes requires an interval for their accumulation and collection, but wartime demands are immediate and must be met before taxes can be obtained. As a matter of administration heavy taxes increase the diffi- culties of collection and evasion is proportional to the pressure of the tax. Since a war cannot be financed entirely by taxation, taxes should not be so heavy as to interfere with the issue of necessary loans. 3. Conclusions — ^The use of taxes in financing a war appears as an indispensable adjunct to a loan policy. If taxes are adequate to meet the interest on all its loans, a nation's credit remains unimpaired. But in addition to this function, a taxation policy may be used for defraying part of the expenses of the war. If a country has a broad and diversified scheme of taxation, in whicK the levies are light during times of peace, it is in an excellent posi- tion to expand the existing system by Increasing the rate of taxation ; but in addition new channels of taxation must be tapped, primarily " Scott, W. R,, and Pigou, A. C, ibid. Digitized by Microsoft® "■16 INTERNAtlONAL FINANCE AND ITS REORGANIZATION sucK as are adapted to the economic conditions during the war, such as may without injustice or hardship be abandoned after the waTj or may be used in the rapid retirement of the debt. ](c) Combination of Loans and Taxes I. Theory — ^Theoretically, a war could be best financed by taxation. Practically, such a plan is impossible. To take the entire social surplus for the use of the state would imply that we have a socialist state, that the social motive had completely dis- placed the individual motive. But under the present regime the motive of self interest still functions. Wars cannot be financed entirely by taxes. Theoretically the socialist state might finance a war correctly. But theoretically socialist states will not fight. Apparently, therefore, the states of the modern order that do fight, must in financing their wars cause suffering to the poor of the war-waging generation and of the bond-redeeming generations. "Why we are content, in the beginning, with socializing for war only within the narrow limits of the military forces is probably not hard to explain. We know that the present economic system works and we think we know how it works. We have faith that we can get immediate results by using the driving power of love of gain, or at least by giving a money reward to those who make war products. Any radically different scheme of industrial organiza- tion for war, substituting, as it would, new and untried motives of human action for the old and tested springs of action, would be experimental. The building of an entirely new industrial S3rstem would require time, time which we can ill spare in the rush of war preparation. Then, too, the consequences of the possible failure, during war, of such an experiment are too awful to con- template." " The difference between loans and taxes as methods of financing a war disappear if the after-war taxation has the same incidence as war-time taxes would have under a just all-tax plan. Ths danger is that the vested interests may be able to shift the burden to the poor and politically impotent and unorganized classes. In other words, the theoretical benefits of an all-tax policy of war finance may be secured by an equitable tax scheme after the close of the war. Since moderate taxes after the war can be made more " Plehn, Carl C, ibid. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 17 just and less escapable than heavy and hastily prepared tax schemes during the war, the leading objection to the loan policy of war finance falls to the ground. Under the present economic order, the individual must be per- mitted to retain a portion of his surplus income in order to stimulate him to effort. The state can, however, obtain the benefits that would accrue to it under an all-tax policy, by preventing its citizens from wasting their surplus, by regulating capital issues, by restrict- ing lending abroad, by conserving bank credit, by liquidating assets held abroad, and by forced loans to take up the surplus income. In conclusion, it may be said that under the present economic regime wars must be financed partly by loans and partly by taxes. No tax scheme can be perfectly just. A loan scheme may be less inequitable than some tax programs. Taxes reach only the honest rich. The dishonest rich or social slacker dodges the tax. Loans bring to the service of the warring nation funds from the tax dodger and reach the large number of tax-exempt. Loans filter into nooks where taxes cannot reach. Inflation, whether by bonds or by deposits or by paper currency, hits everybody, rich or poor, regard- less of ability to pay. We have not yet learned how to finance a war without using all three methods, taxes, loans and inflation. 2. The PRACTICE — ^There are several principles which deter- mine the relative reliance upon loans and taxes in the financing of a war. Primarily, the war must have popular support. The political principle underlying the financing of the war must be rooted in the hearts of the people, so that the patriotic appeal may be made effectively, even at the expense of economic considerations. Again, the fiscal principle is important, that the financing of war should be merely a development of the peace-time fiscal program. The weakness in Germany's financing of the World War was the lack of power on the part of the federal government to levy an income tax. French fiscal policy during the war was hampered because the income-tax program put into effect before the war had not been perfect in its administrative details. The brilliant success of America's war financing was due to the almost providential in- auguration of the income tax in 1913. Britain's time-tested income tax was the backbone of her financial structure. Finally, the psychological element is important. Steep taxes are borne willingly if the rates are gradually raised to a high level which would call Digitized by Microsoft® 1 8 INTERNATIONAL FINANCE AND ITS REORGANIZATION forth strong protests if levied suddenly. The confidence of the people and their approval of the w^ar aims are the limits within which the fiscal policy of the war must be framed. In considering the apportionment of loans and taxes in the financing of a war, the prime principle that operates is that loans and public credit are always a means of anticipating assured revenue. Assuming a suitable system of taxation, public funds may be ob- tained soon after the beginning of a war. During the transition period at the outbreak of war taxation should be light so as to permit the rapid adjustment of industry to the war-time program. Subsequently, however, the rates of existing taxes should be in- creased and new taxes instituted to meet as much of the extra- ordinary expenditures of the war as is possible, to the limit that war-time production is not curtailed. In short, a sound financial program for the conduct of the war requires first, that taxation be adequate to meet the interest on the growing debt so that the government may preserve its credit unim- paired and support the price of its outstanding securities, and second, that as much of the extraordinary expenditures of the war as Is possible must be met out of extraordinary revenues, out of war taxes. The rest of the funds may be raised by loans. Loans should bridge the gap between war expenditures and war taxes. These may be issued continuously, or in drives within limited periods. Again, temporary loans may be issued in anticipation of tax receipts or in anticipation of the proceeds of long-term bonds. The tax program if carefully planned at the beginning of a war may be so elastic as to stand unchanged until the conclusions of hostilities. However, as between loans and taxes, the burden during war should be gradually shifted from loans to taxes short of the point of inter- fering with the production of goods essential to the conduct of the war. B. National Wealth and War Debts In considering the relation of national wealth and war debts, one must make allowance for several sources of error. i. National Wealth The figure for national wealth is taken to be the sum of the wealth of the individuals in the country. However, this is not an Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 19 accurate Standard. The wealth of a nation is not fixed. It depends not only upon its natural resources, but also upon its human re- sources and its economic policy. The wealth of a nation may rise or fall depending upon a change in any of these factors. The growth of Germany in the two generations before the war and the decline of Spain and Portugal from their position of leadership in the sixteenth and seventeenth centuries serve to indicate upon how many conditions the wrealth of a nation depends. Before attempting to interpret figures of public debt and national wealth or of debt charges and national income, it would be well to investigate the accuracy of the figures. Their value would be nil if the error in the determination of any one figure would be greater than the difference between the corresponding figures for two countries. The sources of error have been pointed out by J. S. Stamp, in his "British Income and Property" (1916), and in his paper "The Wealth and Income of the Chief Powers." ^* There are differences in the definition of wealth and of income and there are differences in the methods of determining them. There is a subjective aspect to estimates of wealth. Cowrie shells have higher value for savages than a Rembrandt has. Again, objectively is the national wealth of a nation the sum total of the personal wealth of the inhabitants, or is the national debt to be deducted therefrom ? Furthermore, the wealth of the country may be regarded as the sum total of goods within its boundaries. Some economists, like J. Ellis Barker,^^ would include the undeveloped natural resources, or, it might be, the wealth of the inhabitants, including their foreign possessions but excluding the wealth within the country held by aliens. In addition, estimates of wealth would vary with the degree of ownership from undisputed possession of personal property through the various stages of part interest, trusteeship, and communal wealth. Finally, any periodic or accidental fluctuation in prices or in value would affect the figures of national wealth. Income, on the other hand, would be subject to errors in estimating such earnings as are not paid for in money, as of women and other members of the family in the home. Even if some common definition of wealth and of income were agreed upon in the several countries, there would still remain "The Journal of the Royal Statistical Society, July, 1919. "Nineteenth Century, May, 1918, p. 928. Reprinted in his "Economic Statesmanship," New York, E. P. Dutton & Co., 1919. Digitized by Microsoft® 20 INTERNATIONAL FINANCE AND ITS REORGANIZATION errors arising from the differences in the methods of determination. Data based on taxation statistics are subject to errors resulting from evasions of the tax, omission of certain forms of wealth or income from the tax scheme, and variation in the ratio of income to capital. Income and wealth estimates based on the returns in the annual taxation of capital are subject to local variation and to differences in method of assessment. Inheritance-tax figures have inherent sources of error, when used as a basis for the determination of national wealth. The inventory method, used in the American census, does not account for foreign ownership, omits some forms of wealth, counts some items twice, and divorces earnings from capitalization. Finally, the scientific "census" method calls for a statement of wealth and income from every resident, and in this method also there are several sources of gross error. Therefore, figures of national wealth must be used with reservations. ii. Real Wealth and the Paper Debt The estimated national wealth of the belligerents amounted to about $600,000,000,000. The war debt is approximately $220,000,000,000. However, the inference that three-eighths of the wealth of the belligerents has been destroyed, is unwarranted. Have lands, forests, mines, factories, homes, ships, railroads, stocks on hand and cash, all assets been three-eighths destroyed? The primary source of error is in the fluctuation in the unit of value. The present units of currency have not the same purchasing power as they had before the war. In other words, the unit in terms of which the war debt is expressed is not the same as that in terms of which the pre-war national wealth is figured. With some of the currencies in Europe depreciated over 90 per cent in terms of the dollar, it is grossly inaccurate to assume that the war cost repre- sents any such fraction of the national wealth as the figures would seem to indicate. Part of the debt was incurred to meet the needs of the com- munity for food and clothing, which would have had to be satis- fied in times of peace. This inevitable consumption was not a loss, except insofar as the consumption was greater during war than during peace. The mere fact that these goods were purchased collectively instead of by individuals, that they were paid for by the state instead of by the consumer himself, does not mean that such consumption represents a loss. Furthermore, the obsolescence Digitized by Microsoft® PEINCtPLES AND PEACTICE IN THE WORLD WAR 21 of machinery, and the depreciation of the national plant do not represent entirely a war loss, for they take place during peace as well as during war. In aligning the national energies to the pro- duction of essentials, like food and clothing, there is a diversion or a transfer of the forms of wealth. The subjective element enters here. Since the standards of peace differ from the standards of war, it is not sound to argue that the production in times of wai of goods not used in times of peace constitute waste entirely, for to some extent new or substitute satisfactions replace the old. Of course to a large extent war-time industrial production consti- tutes outright waste as in the manufacture of munitions of war. On the other hand, the decline in the production of luxuries is not a loss of wealth. In fact, peace-time extravagance is similar to war-time destruction, so far as the national wealth is concerned. As a compensation for the losses of war are the new factories built during the war that are capable of being utilized for peace pur- poses. Again, new iridustries are developed and the capacity of old ones increased. The costs of the war are met by increasing the nation's productivity, by reducing consumption and thus in- creasing the surplus. Production is maintained by reason of the replacement of men by women and children. To the extent that decreased production is balanced by decreased consumption there is no loss of national wealth except where the decline in consump- tion cuts into the nation's vitality. The real loss in national wealth consists of the loss of man- power, by -death or incapacity. Again, some of the capital accumu- lated in the past is destroyed, — cities, cathedrals, ships, railroads and other capital goods, or the means of production. The loss of territory and of natural resources may be regarded as a loss to a particular country, but it does not constitute a world loss, except insofar as the losing country may be better able, temporarily or permanently, to utilize or develop them. The great material loss of war, however, consists of the loss of current production, war materials, powder, shells, and munitions. These goods do not satisfy reduced or substitute needs. They represent a dissipation of national assets. Furthermore, the failure to produce an annual surplus of goods out of current production which the nations had been accumulating before the war at the rate of ten billion dollars per year, is a very large loss. The national wealth was destroyed insofar as the future productivity of the world was reduced by Digitized by Microsoft® i2 INlERNAtlONAL FINANCE AND ITS REORGANIZATION undernourishment of the population or the development of internal economic disorder.^" In discussing national debt in its relation to national wealth a distinction must be drawn between the domestic and the foreign debt. A foreign debt requires annual interest payments which may be effected by an exportation of goods, and to that extent the debt represenfs a diminution of the real wealth of a country. But an internal debt is a paper debt ; it does not diminish the wealth of the nation as a whole. Repudiation of the internal debt, a capital levy, or a scaling down of values, would leave the nation's wealth unaffected although it might disturb the economic condition of the country. A paper debt, held internally, never ruined a country. During the Revolution France repeatedly repudiated her debt, and yet at the end of the period was undoubtedly richer than at the beginning. On the other hand, the loss of capital goods, the wealth- producing resources, has ruined nations in the past. During the Thirty Years' War the population of Germany was greatly reduced and the national equipment, the farms, and the industrial centers were largely ruined. The Arabian Empire was destroyed when the Turks demolished the irrigation system of Mesopotamia upon which its agriculture depended. The wealth of Venice was de- stroyed when the change in trade-routes from the Mediterranean to the Atlantic depreciated the importance of her facilities. iii. The Future Outlook History shows that the rate of increase of wealth in the past has been far more rapid than that of the increase in the public debt. The national debts that staggered the statesmen that in- curred them were lightly borne by later generations, Macaulay quotes the wailing of British statesmen in the seventeenth and eighteenth centuries because of the seemingly stupendous debts which they incurred or which were left to them to handle. " 'A million a year will beggar us,' said the patriots of 1640. 'Two millions a year will grind the country to powder,' was the cry in 1660. 'Six millions a year and a debt of ten millions!' ex- claimed Swift; 'the high allies have been the ruin of us.' 'A hundred and forty millions of debt!' said Junius: 'well may we say that we owe Lord Chatham more than we shall ever pay, if we owe him such a load as this.' 'Two hundred and forty millions of debt,' cried all the statesmen of 1783 in chorus; 'what abilities " Kriegskosten und Volksvermogen, ibid. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 23 or what economy on the part of ministers can save a country so burdened?' . . . "Such was the origin of that debt which since has become the greatest prodigy that ever perplexed the sagacity and confounded the pride of statesmen and philosophers. At every stage in the growth of that debt the nation has set up the same cry of anguish and despair. At every stage in the growth of that debt it has been seriously asserted by wise men that bankruptcy and ruin were at hand. Yet still the debt went on growing; and still bankruptcy and ruin were as remote as ever. . . . "We know that if since 1783 no fresh debt had been incurred, the increased resources of the country would have enabled us to defray that debt at which Pitt, Fox and Burke stood aghast. Nay, to defray it over and over again, and that with much lighter taxation than that which we have actually borne. On what prin- ciple is it that when we see nothing but improvement behind us, we are to expect nothing but deterioration before us? . . . "The prophets of evil were under a double delusion. They made no allowance for the effect produced by the incessant progress of every experimental science and by the incessant efforts of every man to get on in life. They saw the debt grow, but they forgot that other things grew as well as the debt. They greatly overrated the pressure of the burden. They greatly underrated the strength by which the burden was to be borne." ^^ The debt dwindles as the resources of a country are unlocked and its manufacturing capacity increased. The figures of the public debt and national wealth of Great Britain illustrate this point. National wealth PubUc debt ' (in million pounds) (in million pounds) Year Amount Year Amount 1703 490 1727 52 1774 1,100 I77S 127 1800 1,740 1793 248 1812 2,190 181S 861 1833 3,7So 1854 77S 186s 6,"3 1899 S99 1903 15,000 1914 678 1918 24,000 (Mar. 31) 1918 S899 '^ Macaulay's History of England, vol. v, ch. xix, pp. 2^284-2,286, edited by C. H. Firth; Macmillan, London, 1914. Digitized by Microsoft® 24 INTERNATIONAL FINANCE AND ITS REORGANIZATION In Other words, the national wealth increased three times in the eighteenth century and about ten times in the nineteenth century, or thirty times in 200 years from 1703 to 1903. How- ever, the national debt had increased about thirteen times in the same period, that is, prior to the World War. A similar table covering the United States shows the same difference more strikingly. The national wealth increased six times, but the public debt declined over 50 per cent in 50 years. Year National wealth (in million dollars) PubUc debt (in million dollars) 1870 i8go 1912 30,069 65,837 187,739 2331 891 1028 The universally rapid increase in the wealth of nations is due to the increase in the productivity per man and to the continuous depreciation of money, owing to the increase of the gold supply and more particularly to the increase in the forms of commercial credit. The increase in productivity is due to the application of engineering to industry, to standardized production and to auto- matic machinery. The depreciation of the currency even in times of peace is an historic phenomenon. In view of the fact that the war debt is a money debt and also that wealth and income are increasing at an accelerated rate, the repayment of the debt will ultimately involve as little a burden to later generations as the repayment of the debt of the Napoleonic Wars did. The tax revenues of Great Britain in 181 5 were about 70 million pounds, and in 191 7-18 about 700 million pounds. The wealth and taxable income of Great Britain increased tenfold in the century since 1815. More striking is the growth of the national wealth of the United States, which increased twenty-six- fold since 1850 and three-hundred-and- forty- fold since 1790. If the British Empire adopts in the colonies the methods used by the United States in attaining its present industrial development, the wealth of the Empire will be sixty times as great in the year 2000 and one thousand times as great in the year 2100 as it is to-day. The present war debt will then appear smaller than the Napoleonic debt appears to us."* "Barker, Ellis, Britain's True Wealth and the Unimportance of the Digitized by Microsoft® PRINCIPLES AND PEACTICE IN THE WORLD WAR 2$ However, as deflation follows a war, the burden of repayment of debt will temporarily increase. The money which is repaid within a generation will have a greater purchasing power than that which was borrowed. C. Statistics of Public Finance i. National Wealth and Income In a consideration of the question of the debts arising from the World War, the figures of national wealth and income over a period of years are of interest. In addition to presenting a fairly accurate picture of the rate of growth of the national wealth and income, such a table shows the relation between the rate of growth of the national debt and that of the national income. As J. C. Stamp points out in his careful study, "The Wealth and Income of the Chief Powers,^^ the methods of computing national wealth and income are based on so many diverse factors and are calculated in so many different ways that the comparability of the figures for several nations may well be challenged. How- ever, granting even a large percentage of error, the rate of growth over a period of years is so much greater than the probable degree of error, that a series of figures for national wealth and for national income for the same country are not without significance. Taking the figures for the last quarter of the eighteenth century as a basis, we find that up to the beginning of the World War the national wealth of Great Britain increased about fourteenfold and the national income about nineteenfold. On the other hand the national debt of Great Britain at the beginning of the World War was hardly five times as great as in 1763, although for almost a century after the Napoleonic Wars the debt was slowly de- creased. The actual revenue collected in the United Kingdom grew twentyfold from the middle of the eighteenth century up to 1913. The national wealth of France increased sevenfold from 1789 to 191 3, and the national income increased about ninefold in the same interval. The public Jebt of France, however, increased War Debt, The Nineteenth Century, July, 1918. Also his "Economic Statesmanship," E. P. Dutton & Co., 1919. "Journal of the Royal Statistical Society, July, 1919. Digitized by Microsoft® 26 INTERNATIONAL FINANCE AND ITS REORGANIZATION about twelvefold from 1763, more rapidly than the national wealth. The actual revenue increased about thirteenfold from 1750 to I9I3> The growth of the debt from 1763 to 19 14 was about the same as the growth of the income and of the actual revenue in the same period. This fact is due to the many wars fought by France, to the maintenance of a large public debt, and to the decline of com- mercial activity and influence. ESTIMATES OF NATIONAL WEALTH AND INCOME 2* National Wealth of the United Kingdom Year Million dollars Relative figures Applying to — Authority 1660 1.250 23 England and Wales Petty 1703 2>4So 44 Davenant 1774 S.Soo 100 Young 1800 8,700 158 Great Britain Beeke, Edin. 1812 10,950 198 United Kingdom Colquhoun 1822 13,000 236 Lord Liverpool 1833 18,750 340 Pablo Pebrer 1840 20,500 373 Porter i860 29,800 542 (interpolated) 186s 30,565 S5S Giffen 187s 42,740 77S 188s So,i85 90s 1888 S4,ooo 982 1913 79,500 1445 Crammond 1914 70,500 1280 Stamp National Income of the United Kingdom Year Million dollars Relative figures Applying to— Per capita 1664 210 34 • England and Wales 390 1688 225 37 41.0 1770 610 100 81. s 1800 1,150 188 130.0 1822 1,400 230 Great Britain 99.0 1840 2,520 413 United Kingdom 96.0 i860 3,800 623 131 1889 6,425 loss 168.0 1914 10,900 1790 (Stamp) 193s (Crammond) f ( 238.0 1914 11,800 2s8.o ^■"The Dictionary of Statistics, Michael G. Mulhall, George Routledge & Son, London, 4th ed., 1899, pp. 320, 321, 589, 593; also Webb's Supple- ment: Statesmen's Year Book; Stamp, J. S., Wealth and Income of the Chief Powers ; and the Statistical Abstracts and Yearbooks. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 27 Nationai Incobie of France National Wealth of France Year Million Per Relative Year Million Relative Authority dollars capita figures doUars figures 1780 800 30.5 100 1789 7,600 100 Lavoisier 1800 1080 38.S 13s 181S 9,000 119 Chaptal 1820 IS7S S2.0 197 1820 12,600 166 (interpolated) 1840 Z400 70- s 300 1826 14,200 187 Guyot 1868 4030 108.0 S04 i8s3 25,000 329 Girardin 1871 3S,ooo 460 Wolowski 1888 5230 139 6S4 1882 4S,SSo 598 Flaix 1913 7290 184.3 911 1913 58,300 717 Pupin ii. Growth of Public Debt of the Nations In the two centuries from 1713 to 1913, the pubh'c debts of the countries for which figures are known increased about seventy times. In the eighteenth century they increased about fourteen times and in the nineteenth century about five times. As a result of the World War they increased about six times. The grOwth of public debts was due largely to war and to preparation for war, and to a less extent to government-owned public improvements. The growth in the debt from 171 3 to 1889 was estimated by Mul- hall to be divided as follows: Use Amount in million doUars Per cent War and armaments 18,050 7,200 3>9oo 80s 60 Railways and telegraphs 13 Sundries Total 29>9SS 100 The increase of the debt of the nations of the world may be seen in better perspective when viewed in connection with the historic process of inflation of the currency and the rise in com- modity prices. Whereas the public debt of the principal nations rose from about $9,000,000,000 in 1848 to about $43,000,000,000 in 19 1 3, or about five times, the gold production of the world rose from about $13,000,000 per annum in the decade 1831-40 to $460,000,000 in 1 91 3, about thirty-five times. The public debt Digitized by Microsoft® 28 INTERNATIONAL FINANCE AND ITS REORGANIZATION Public Debt or the Pbincipai, Nations '' (in million dollars omitted) 1 713 1763 1793 1816 1848 1870 1889 1913 Great Britain France 270 240 735 550 75 55 1850 160 235 210 100 5 350 10 4500 700 19s 725 495 125 585 35 SSo "60 386s 1300 345 450 625 180 565 iro 57° 125 60 10 so 4,005 2,520 740 1,710 1,700 1,665 1,425 295 380 140 65 30 90 460 3,490 6,345 (0) 240 3.780 2,900 2,300 1,300 565 445 385 55 100 US 900 180 65 3,486 6,346 Gerrnany Russia 1,177 4,537 SO 3,799 Italy 2,852 Spain 35 .... 1,814 Portugal Holland Belgium Denmark Sweden and Norway Greece Turkey Roimiania Serbia Other Europe 948 462 82s 96 259 188 667 317 126 159 Total Europe . . United States Latin America .... Canada Australia India 595 I 41S 2920 85 45 7970 130 145 825s 50 85 25 255 10 15.225 2,425 675 8S i8s 540 50 i8s 10 23,165 1,105 1,665 245 855 930 250 515 135 28,058 1,028 2,396 483 1,429 1. 471; 1,242 South Africa Other countries... . 459 573 5,797 Total World... 595 141S 305° 8245 8680 19,380 28,865 42,940 Relative figures . . . 42 100 216 583 614 1,372 2,039 3,040 (a) Mulhall's figure for the German debt in 1889 is equivalent to 2175 million dollars. In view of the small debt in 1870 and the large indemnity received from France, his figure is obviously incorrect. The Statistical Yearbook of the German Empire gives the debt on March 31, 1889, as loio million marks. of the world rose from $3,000,000,000 in 1793 to about $45,000,000,000 in 1913 or about fifteen times, whereas the world supply of credit probably grew sixty fold in the same interval. °' Figures up to 1889 are taken from Mulhall, pp. a£o, 699. The 1913 figures are taken from the Statistical Abstract of the United States. Digitized by Microsoft® PRINCIPLES AND PKACTICE IN THE WORLD WAR 29 For example, the deposits of the Bank of England in February, 1793, were about £5 million^* and on July 29, 191 4, about £65 million, of public deposits and about £270 million of private de- posits, an increase in total deposits of about 67 times."^ The world's debt in 191 3 therefore was relatively smaller than in 1793. iii. The Cost of Previous Wars In the 120 years from 1793 to 191 3, the cost of wars amounted to over $24,000,000,000, or about three-fifths of the difference be- tween the debts of the world at the two dates. The expenditure of the United States in former wars amounted to $5,692,000,000, distributed as follows: War 1812-1815, with Great Britain $ 119,000,000 War with Mexico, 1846-1849 173,000,000 Civil War, 1860-1865 3,478,000,000 Spanish-American War, 1897-1900 , 1,922,000,000 The cost of wars to Europe in the same interval amounted to about $18,400,000,000 distributed as shown in the table on page 30.^* The cost of the World War was over six times as great as the cost of all the wars in the previous 120 years. The third British war loan issued in 1917 was almost as great as the entire cost of the 22 years of war with France, ending in 1815. The Fourth Liberty Loan, floated in October, 19 18, was twice as great as the total cost of the Civil War and greater than the cost of the Napoleonic Wars. The total cost of the wars of Europe and of the United States from 1 793-1913 was less than the increase in the debt of the British Empire during the World War. The cost of the wars in Europe during the same period was about half of Germany's in- crease in debt during the World War. iv. Growth of World Revenue The rapid increase in the public debt in the past two centuries was more than matched by the increase in the revenues of the principal countries. Whereas in the period from 1713 to 1914 the '"Report of Committee on Charter of Bank of England, 1831-2, Ap- pendix No. 5, presented in Canaan's, The Paper Pound of 1797-1821, London: P. S. King & Sons, 191 9. "London Economist. ™ Statement of the Liberty Loan Bureau, Treasury Department, November 10, 1917. Digitized by Microsoft® 30 INTERNATIONAL FINANCE AND ITS REORGANIZATION Dates 1793-181S 1812-1815 1828 1830-1840 1830-1847 1848 1854-1856 1859 1864 1866 1864-1870 1865-1866 1870-187 I 1876-1877 igoo-iQoi 1904-1905 1913 Countries engaged England and France France and Russia. > Russia and Turkey Spain and Portugal France and Algeria Revolts in Europe England France Sardinia and Turkey Austria Russia France Austria Italy Denmark, Russia and Austria. . . Prussia and Austria Brazil, Argentina and Paraguay. France and Mexico Germany France Russia Turkey Transvaal Republic and England Russia and Japan Balkan Wars . ." Total Costs $6,250,000,000 451,000,000 100,000,000 250,000,000 190,000,000 50,000,000 371,000,000 332,000,000 128,000,000 69,000,000 800,000,000 75,000,000 127,000,000 51,000,000 36,000,000 330,000,000 240,000,000 65,000,000 954,000,000 1,580,000,000 807,000,000 403,000,000 1,000,000,000 2,500,000,000 1,264,000,000 $18,423,000,000 public debt of the principal countries of the world increased about 72 times, the revenue increased 122 times from 1680 to 1913. In the century preceding 1913 the public debt increased about five times and the revenue increased about twelve times. In other words the rate of increase of public revenue is greater than the rate of increase of the public debt, particularly during the nineteenth century. During the eighteenth century the revenue increased about sixteenfold and the public debt about fourteenfpld. Several important conclusions may be drawn from these facts. First, wars do not impoverish the world permanently. Again, industrial development proceeds at such a pace that the public revenues may be rapidly increased. This would indicate that governmental Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 3 1 policies, fiscal or otherwise, should interfere as little as possible with the development of industry in order that the growth of wealth may in itself cause the burden of the public debt to diminish. One may not conclude, however, that war pays, for the growth of wealth in the nineteenth century was due to scientific and technical achievements and not so much to the grabbing of neighbors* lands, for this constituted merely a transfer of wealth from country to country and not a net increase of the wealth of the world. Great Britain, which engaged in only four wars from 1793 to 1913, experienced a much greater increase in national wealth than France, which engaged in six in the same period. The table on page 33 gives the revenues of the principal coun- tries of the world. That the world's revenue tends to increase more rapidly than the world's debt is evident in a comparison of the ratio of revenue to debt in 1750 and 1889, in which years the figure was about 16 per cent, and at the outbreak of the World War when the ratio of world revenue to world debt was about 25 per cent. The period from 1750 to 1889 was one of almost continuous warfare, and therefore of mounting debt. Yet the growth of income kept pace therewith. But the interval from 1889 to 1914 was a period of relative peace and therefore while the debt of the world increased more slowly, the revenue rose considerably. D. Total Cost of the War^^ The estimate of the cost of the war depends upon the adoption of a national or world point of view^. The loss to one country of territory or of natural resources constitutes a mere transfer of wealth, so far as the world is concerned. The world loses as a result of such a transfer only if the new owners for any reason are unable to produce additional wealth as economically as the former owners. ^ Rapport General, Chambre, France, a study of war finance of the chief belligerents, No. 4133, 1918, pp. 9-291 and No. 6158, 1919, pp. Sz3°°- Laughlin, J. Laurence, Credit of the Nations, N. Y., Scribners, 1919. Bogart, E. L., The Direct and Indirect Costs of the World War. New York: Oxford University Press, 1919. Seligman, E. R. A., The Cost of the War and How It Was Met, American Economic Review, ix:4, 739-770, December, 1919. Gottlieb, L. R., Indebtedness of Principal Belligerents, Quarterly Journal of Economics, xxxiii:3, 504-531, May, 1919; Debts, Revenues Digitized by Microsoft® 32 INTERNATIONAL FINANCE AND ITS REORGANIZATION i. Errors in Estimating the Cost The intangible costs are indeterminable. The loss in satisfac- tion of human wants during the war, the pain and suffering of the combatants, the worry and grief of the civilian population, the social unrest following the war, and the obstructing of social progress are all incapable of being measured. In attempting to estimate not the indefinite and intangible costs of the war but the financial cost the student is confronted by a number of difficulties. Not only are the real costs impossible to appraise, but even the money costs of war are difficult to determine. (a) The Time Factor — The beginning of war expenditures may be fixed at a definite date, but the end cannot be so fixed. The expenditures resulting from war do not end with the cessation of hostilities, with the de- mobilization of the armies, nor with the signing of the treaty of peace. For the world as a whole, expenditure resulting from war continues until the ruins are repaired. But for each nation, the war cost may include the payment of reparation to other countries and the payment of pensions or relief moneys to its own inhabitants. It is not scientifically accurate to charge to the cost of the war the expenditures for housing, extension of railroads, and the many other accumulated demands of normal years, the satisfaction of which was deferred during the war. But the excess cost of these expenditures above normal years is attributable and chargeable to the war. (b) The Currency Factor — All calculations of the cost of the war are subject to another serious drawback. No measurement of quantity can be accurate if the unit in terms of which the results are expressed varies con- and Expenditures and Note Circulation of Principal Belligerents, xxxiv:i, 161-205, November, 1919; Las Finances d'Apres Guerre, Revue de Science et de Legislation Financidres, xviii:4, pp. 613-713, October, 1920. Ayres, L. P., The War with Germany. Washington: Government Printing Office, 191 9. Jize, Gaston, Les Finances de Guerre, Les Methods Financidres, Les • Emprunts de Guerre, are surveys of the major powers, in the Revue de Science et de Legislation Financiires, 1915-1920. _ Internal War Loans of the Belligerent Countries. New York: National City Company, 1918. See also the sources and references under chapters dealing with in- dividual countries. Digitized by Microsoft® jRiNCiPLEs And practice in the world war 33 Reventtes of the Principal Countries '" (in million dollars) Country 1680 1750 i8io 1850 1889 1913 United Kingdom France Germany Russia Austria Italy Spain Portugal Sweden Norway Denmark Netherlands Belgium Switzerland Greece Turkey Other Europe (estimated). Total Europe . . . United States Canada Mexico...^ Cuba Argentina Brazil Chile Peru Venezuela Colombia India Persia Japan China , South Africa Egypt , Australia Other count ies (est.) . Total World. Relative figures . . 10.6 24.0 10. o 2.0 9.6 18.8 75° iS-o 90.0 36 46.0 71.0 35° 8.0 20.0 7-5 16.6 14.9 279 200 57 55 52 23 30.0 6.0 5-° 5-5 24.0 ISO 18.0 291.0 2550 119. o 19s o 100 60 57 16 7 4 7 29 23s 5-0 50 4S-0 30.0 442-5 609.0 336 o 444.0 374.0 360.0 177.0 42.0 24.0 12.0 iS-o 50.5 64. S 14- S iS-5 116. o 70.0 230.0 250.0 770.0 9-5 i.o 9.0 78.0 32. S 1250.0 46.0 5-5 15.0 7-5 4-S 20.0 S-o 10. o 2-5 2.5 138-0 7-S 25.0 90.0 2-5 20-0 4-5 44.0 3166-5 403.0 38-0 27.0 12.5 27.0 70-5 25-0 7 5 5 276 6S 130 20 48 138 126 918.8 914.6 879.7 i>832-S 1,167- S S12-8 224.9 82.0 73-4 41.6 30.6 91.8 146.2 19.0 25-9 134-3 239-7 900.0 1700.0 4600-0 360 680 7,335-3 1,014.1 168.7 64-S 37-9 145-3 192.7 72-4 17-3 10. 1 14. 1 386.2 10.? 292-2 193-3 84-6 79-7 28s- 589.0 10,993 -3 4400 "Mulhall's Dictionary of Statistics, 4th ed., pp. 257, 699, revised for India and Germany by comparison with figures in Statistical Abstract for India for 1S89-1890, the Statesman's Yearbook, 1899, and the Statistisches Jahrbuch fuer das Deutsche Reich. The 1913 figures are taken from the Statistical Abstract of the United States. Digitized by Microsoft® 34 INTERNATIONAL FINANCE AND ITS REORGANIZATION tinually during the process of measurement. How tall would the Woolworth Building be if the unit of measurement, the foot, be- came shorter as one approached the top? Or what would be the distance between New York and Washington if the mile shrank in length while one measured? Inflation went on continuously during the war and for a while after its close. For example on February 28, 1920, measured in terms of dollars the pound sterling was depreciated 30 per cent, the French franc 64 per cent, the Belgian franc 62 per cent, the lira 72 per cent, and the mark 96 per cent. Or measured in terms of internal values of a country, the currency depreciated in terms of other commodities, and prices rose continuously and caused a continuous increase in expenditure as the war continued. The increase in the note circulation, which is presented below, shows the unreliability of the unit of currency as a measure of the nominal or money cost of the war. (c) The Administrative and Accounting Factors — The technical aspects of the question also make exact determina- tion of the cost of the war difficult. The strain of war played havoc with budget calculations so that they no longer were con- sistent or comparable with peace-time budgets. Furthermore, civil expenses could not be strictly separated from military expenses, such as wage bonuses, bread subsidies, and civilian relief. Profits or losses from operation of government enterprise were ascribable to the war in some instances and yet were not so. shown. Bonds were ofiEered at a discount, so that the actual cash received does not tally with the par value of the debt which is counted as the cost of the war. Treasury bills were included as well as the bonds into which they were converted, or the taxes for which they were receivable. In addition to these difficulties in estimating the cost within any given country, additional complexities arise in comparing the figures for several countries. At best the comparing of budgets must lead to inaccurate conclusions, owing to a lack of uniformity in their items. Finally, the withholding or juggling of facts, as best served the expediencies of the moment, has added an additional element of inaccuracy in the determination of the exact amount. (d) International Aspects — While the cost of the war to the world as a whole will not be affected if international obligations are not carried out, the cost Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 35 to individual nations will greatly vary. If Germany does not pay the reparation charges to Belgium and to France the cost of the war to each one of them will be different than if she does carry out her treaty obligations. Then there are the inter-Allied loans, which were extended by the United States to her associates and by Great Britain and France to the Allied Powers. According to Austen Chamberlain, Great Britain has already written off 50 per cent of the advances that she made. From all sides, with increasing pres- sure the suggestion is put forward that all inter-governmental loans be canceled. Under no conditions should the inter-governmental advances be counted twice in calculating cost to the world. If the debt is to be paid it should be included in the cost of the war to the borrower but not to the lender. If the debt is canceled by the lender or repudiated by the borrower, it should be counted as a cost of the war to the lender. At all events, until the final disposition is made of these debts, among the Allies, it will be im- possible to give an unconditional estimate of the cost of the war to each of the powers involved, though of course the world totals will not be affected. ii. The Direct Costs of the War The direct costs of the war constitute the actual cash expendi- tures incidental to its prosecution. They are definite in nature if not always ascertainable in amount. To the extent that the money is raised through loans, internal or external, or through taxes, the cost may be accurately measured. But the issue of fiat currency and the inflation of credit give the various governments a purchasing power over goods and diminish the purchasing power of the people in a way that makes it impossible to determine the cost precisely. The total direct cost of the war is the sum of the loans and taxes. Money raised by inflating the currency is included in the govern- ments' treasury bills held by the banks of issue, in some cases. (a) The Total Direct Cost— Several estimates have been made of the cost of the war, the variation between which is due to differences as to period covered, and differences as to items included. The Statistics Branch of the General Staff of the United States War Department figured the direct cost ot the World War to be $186,000,000,000. Edgar Crammond in Great Britain estimated the total direct cost of the Digitized by Microsoft® 36 INTERNATIONAL FINANCE AND ITS REORGANIZATION war to be about $210,000,000,000. E. L. Bogart in his very coiii' prehensive study estimated the total direct cost to be $186,333,- 000,000. L. R. Gottlieb estimated that the increase in gross in- debtedness of the principal belligerents was $212,000,000,000, but this sum included about $29,000,000,000 of Russian paper currency, the deduction of which would make the increase of gross indebted- ness $183,000,000,000. Deducting advances among the Allies of about $23,000,000,000, counted twice, the net increase in the debt of the world would be $160,000,000,000. The addition of $32,- 000,000,000 in taxes would make the total direct cost of the war $192,000,000,000. E. R. A. Seligman reckons the total war ex- penditures to be about $232,000,000,000 and the net war expenses about $210,000,000,000. He ascribes his high result to the fact that he used later figures than did other writers. Assuming that the total direct cost of the World War is about $200,000,000,000 this figure is ten times the total foreign invest- ments accumulated by Great Britain before the war, or more than five times the foreign investments of the entire world. The world's annual foreign trade before the war was $40,000,000,000, which is about one-fifth the cost of the war. The world production of gold from the discovery of America up to 19 13 aggregates about $15,000,000,000 or about one-thirteenth of the cost of the war. In terms of American values, the cost of the war to the world is ap- proximately equal to the total estimated wealth of the United States, or over ten times the valuation of the railroads of the United States, or about 400 times the annual value of new build- ing construction, about 50 times the value of our foreign trade before the war, and about 60 times the value of the general stock of gold in the United States, on January i, 1920. (b) Loans — I. Public debt of belligerents — ^The war was financed very largely by loans. A study of this table reveals several striking facts. Before the war the largest public debt was carried by France, with Russia and Austria-Hungary following. After the war the largest debt was carried by Germany with Great Britain, France and Austria- Hungary following. The greatest war debt was incurred by Ger- many and the next greatest by Great Britain. France, Austria- Hungary, the United States and Russia incurred approximately the Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 37 Total War Expekdititres (In million dollars. Foreign currency converted at mint parity) Country Great Britain Australia New Zealand Canada South Africa India British Empire , France Russia Italy , Belgium Roumania Serbia United States Entente Powers Germany Austria-Hungary Turkey Bulgaria Central Powers Total Gross Expendi- tures Loans to Allies Great Britain Fiance Germany United States Total Inter-Allied loans Total net war expendi- tures Amount Period $41,887 1,461 36s i,S45 243 S84 $46,085 32,617 26,522 15,636 1,387 907 63s 32,261 156,050 48,616 24,858 1,802 732 76,008 $232,058 8,467 1,293 2,261 9,102 21,123 210,935 Aug. 4, 1914, to Mar. 31, 1919 Aug. 4, 1914, to Mar. 31, 1919 Aug. 4, 1914, to Mar. 31, 1919 Aug. 4, 1914, to Aug. 31, 1919 Aug. 4, 1914, to Mar. 31, 1919 Aug. 4, 1914, to Mar. 31, 1919 Aug. 3, 1914, to Mar. 31, 1919 Aug. I, 1914, to Oct. 31, 1917 May 23, 1915, to May 31, 1919 Aug. 2, 1914, to Oct. 31, 1918 Aug. 27, 1916, to Oct. 31, 1918 July 28, 1914, to Oct. 31, 1918 April s, 1917, to June 30, 1919 Aug. I, 1914, to Oct. 31, 1919 July 28, 1914, to July 31, 1919 Nov. 3, 1914, to Oct. 31, 1918 Oct. 4, 1915, to Oct. 31, 1918 same war debt. The ratio of post-war to pre-war debt, or the relative growth of the debt, was greatest for Germany with the United States following second. These figures indicate not merely that a large war debt was incurred but also that the pre-war debt had been reduced to very small proportions. For instance, the French public debt before the war was about five times as large Digitized by Microsoft® 38 INTERNATIONAL FINANCE AND ITS REORGANIZATION as that of the United States or Germany, and the British debt about three times as large. The Japanese debt remained practically constant. The victors spent almost twice as much as the van- quished — a striicing commentary on the cost of unpreparedness. The debt of the victors grew sixfold, wrhereas that of the van- quished multiplied about sixteenfold. However, such a statistical generalization is misleading, as the problem of paying the war debt affects each country individually, regardless of its Allies, and there can be no joint action of groups of countries such as will carry into effect the implications of a statistical averaging of the debt. The weak countries overburdened with debt do not find their debt lightened merely because they were the Allies of countries which by reason of wiser financing or more wealth incurred a relatively , smaller debt. ' PuBuc Debts of Belligerents (in million dollars) Country Before the War After the War War debt Ratio of post-war Date Amount Date Amount to pre-war debts Great Britain Aug. 4, 1914 Aug. 4, 1914 Aug. 4, Z914 Aug. 4, 1914 Aug. 4, 1914 July, 1914 July, 1914 May, 191S Aug. 2, 1914 Aug., igi6 July, 1914 Julj;, 1914 Apnl 5, 1917 Aug. 1, 1914 Aug. 1, 1914 Nov., 1914 Oct. 4, 191S 3.16s 472 ill 614 Mar. 31, 1919 Jan. 31.1919 Aug. 31, 1919 Mar. 31, z9rg Mar. 31, 1919 37.221' 1,634 1,684 828 846 34,056 1,162 1.352 341 232 II. 7 35 S-i 1-7 1-3 Canada New Zealand South Africa British £mpit«. . . S.070 6,291 4,623 2,621 722 292 271 1,247 1,190 Dec. 31, 1918 Sept. 1, 1917 May 31, 1919 Apnl 30, 1919 Oct. 3t, 1918 Oct. 31, 1918 July 31, 1918 June 30, 1919 42,213 1,020 730 1,26s 24.232 37.143 26,031 20,760 12,388 1,166 728 ii 23.042 8.3 5S Italy Belgium . . . Roumania 3.5 a. 7 Serbia United States ao.4 Allied Powers 22,327 1,126 3,726 48s 219 144.062 28;s84 2,002 974 121.735 24^858 1.S17 7SS 6.4 42 .3 7-7 4.1 4.4 Germany Oct. 30.1919 July 31, 1919 Oct., 1918 Oct. 31, 1918 Austria -Hungary . . . Turkey Bulgaria S.SS6 80,113 74.556 IS.8 Grand Total 37.883 224,174 196,291 8 • Counting on repayment of one-half of the loans to the Allies, or $3,970,000,000. t The additional debt contracted by the Bolshevist Government is not included. 2. Debt charges — Several important facts stand out. The annual debt charges for nearly all of the belligerents and for each group of belligerents increased more rapidly than did the debt. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 39 ft -a §.3. n P g PL, p." ^Ll tl4 ^moi t*t«^.»o o «^« H o^ M ^lO to O O O lO CO CT» o»eo 00 ta 00 (o •* t^ >ooo H toohdoo ooo « '^'^ "^"^ '^ ■* Q. *l ■^'^ *" totCMt-T cf »n h" lo H W W> tOH « O^ 0> dOO OO 01 O^ O d C^ (7) ro C» pO »0 *0 « <0 0 ^2 t»-T(-'^"t'>*-J"'«t--*'*-*CO Ui Oi o^ en Oi o^ Oi Oi cii Oi mcito 0(0 mo (O CI to rfiOO Ooo ■*0 »0 (OiO 00 ■* to tOO^ 00 -^t^ H (O H WHO CT*-*-* W) to to ^o^ H C4 C»00 Oi O « ■*oo o «(£> to H t- H CTl P OiOOOO 00 o^ to tototd Tj- lO H C4 t^ H <0 to OtD *^ H tOlOlO H to ■<*■ T(- "li' ■^ d Qk Q) Q) C^ rill' "S E-' ^ U4Jh 1. OJO-W-w (S q'C R «4 "I S ^-^ 111 .y'w-S be O en -M S^*J^ v» y O S*j qH MuT^ S •^"^Hja-a « ® 6 >.UT3 O^tJ ««■§ O >.s a s I'' u > S o.Mia o a «ifss§gs| g ^ « c'S rt I «'P O « MQ ^ -"^tS 5 Sl^fl d tOM'+H+JM ^*^'Hu-'^-2 o o P. "^ M rt o S— aJ'*^ «i ^+^J3 Si-" ., ^ < T3^ 3 ,, P M t rj£ B g « P a S^ Digitized by Microsoft® 40 INTERNATIONAL FINANCE AND ITS REORGANIZATION The increase was due to the higher interest rates borne by war loans than by pre-war loans. In other words, the percentage of charges on the debt to the debt itself was greater after the war than before the war. Both before and after the war the percentage of the annual debt charge of the Central Powers was greater than that of the Allied Powers. The growth of the debt was about 6.4 times for the Allies and about 11. 1 times for the Central Powers. The growth of the annual debt charges was about 7.1 times for the Allies and 13.5 times for the Central Powers. Before the war the United States had the lowest percentage of annual charges on the debt and Turkey the highest percentage, although Bulgaria, Greece, Russia, and Japan, paid 4 per cent or more annually on their outstanding debts. As a result of the war there was a general increase in the percentage. The annual debt charges of all the powers enumerated was about $1,000,000,000 before the war, and about $9,300,000,000 after the war. In comparison with the total pre-war annual debt charges of all the powers enumerated, the annual debt charge of Germany alone after the war was twice as great, that of France almost twice as great, that of Britain almost 1.5 times as great, and that of the United States almost as great. Comparing the annual charges before the war and after the war by countries, we find that the ratio of the increase was 52 times for Germany, 38 times for the United States, 12 times for Great Britain, 8 times for France, and 6 times for Italy. 3. Per CAPITA DEBT — Of the major belligerents, the United States had the lowest per capita debt before the war, and Germany was next. Great Britain had a lower per capita debt than Italy, and France had the highest figure on the list, with the exception of New Zealand, whose debt probably include liens on public government-owned industrial enterprises. The per capita debt of France before the war was about 15 times as great as that of the United States, about 10 times that of Germany, and more than twice that of Great Britain, and of Italy. Among the major powers there is a fairly close correspondence between large per capita debts and high rates of interest, an important consideration affecting public credit and financial preparedness for war. Before the war the average debt per capita among the Allied Powers was but slightly greater than among the Central Powers, Combined, Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 4I they averaged about $45 per capita, though this figure represents the mean between wide variants. It has significance only in con- nectibn with the close financial cooperation, which existed during the war. The per capita debt after the war was greater among the Central Powers than among the Allies, the ratio being 1.6 to i. The per capita debt among the major belligerents was highest for Great Britain, with France, Germany, Austria, Hungary, Italy, and the United States following in order. The per capita debt of the United States after the war was about 30 per cent of that of Great Britain, and about 33 per cent of that of France. It is interesting to note that in spite of the fact that Great Britain had the hij;hest debt per capita, the debt charges per capita were highest for France. The reason is obvious. France was unable to borrow at favorable rates because her pre-war debt was very large and because her war-time taxation was ineffective. The debt charge per capita of Germany was second highest and that of Great Britain third in the list. Japan had the lowest figure. The debt charges per capita among the Central Powers was 1 .9 times as great as among the Allied Powers. 4, Debt and national wealth; debt charges and NATIONAL INCOME — Bearing in mind the sources of error in the estimates of national wealth and of national income, it is probably true that the extent of error is not so great as to make meaningless the relation between national wealth and national debt, or national income and annual debt charges. The national wealth and national income before the war are comparable with the national debt and annual debt charges before the war, but not with the post-war figures, which are in terms of inflated monetary standards. There- fore the interpretation of the table showing the financial standing of the principal belligerents must be limited. Before the war the national wealth of the countries known subsequently as the Allied Powers, was 3.5 times as great as that of the Central Powers. The pre-war national income of the Allied Powers was 4.3 times that of the Central Powers. The Allied Powers enjoyed an income of 14.9 per cent on their national wealth and the Central Powers an income of 11.9 per cent. Before the war both groups of powers had mortgaged their national wealth to approximately the same small extent, and the debt charges of the two groups constituted Digitized by Microsoft® 42 INTERNATIONAL FINANCE AND ITS REORGANIZATION a very small percentage of the national income. However, within each of the groups there was a very wide range of differences. Pee Capita Debt and Anntial Debt Charges of Principal Belligerents Country Popula- tion (thou- sands) Before the War Debt per capita Debt per capita After the War Debt per capita Debt charges per capita United States Great Britain Canada Australia New Zealand France Italy Japan Russia Belgium Greece Total Allied Powers. Germany Austria Hungary Turkey Bulgaria Total Central Powers Grand Total 106,653 46,089 8,361 4,971 1,162 39,700 36,717 57,998 182,183 7,658 4,950 $ 11.33 75-03 40.19 18.71 383 82 166.20 82.5s 21.74 27-95 94-28 37-98 $0.22 2.58 1-55 0.60 II. 19 6-35 2.81 0-93 1.20 3-26 1,62 $249-38 817.04 189-45 325-69 631.67 768.11 408.78 22.14 138-30 246 . 67 105.25 58. 38 30-83 13-75 10.06 18-93 48.61 15-71 0.90 4.20 II. 10 364 496,442 67,812 30,958 21,410 21,274 5,518 45-19 17.18 84-99 74.82 31-35 30.99 1.67 0.62 3.26 2.48 2.12 1-45 287.63 589-97 551-42 416. II 94.11 209.86 11-95 32.46 20.09 16.21 4.14 19-75 146,972 643,414 42.43 44-56 1.69 1.68 470.48 329.40 22.91 14-45 The United States' pre-war national wealth was about 45 per cent that of the total for the Allied Powers, and 1.6 times that of the Central Powers. The other countries, in the order of national wealth, were as follows : Germany, Great Britain, Russia, France, Austria, Italy. The pre-war national income of the United States constituted 54 per cent of that of the Allied Powers, and 2.3 times that of the Central Powers. The ratios of income to national wealth show wide variations which may indicate either the greater profitableness of the invest- ments of some countries or the extent of error. Why industrialized Belgium and agricultural Hungary should show the same figures, Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 43 or why the United States, with her abundant resources and rela- tively sparse population, and Italy, with her scant resources and abundant population, should show almost the same returns, are questions that emphasize the limited utility of the figures. Debt and National Wealth: Debt Charges and National Income (in million dollars) Country Pre-war natioaal wealth Pre-war pational income Ratio of income to wealth Debt as percentage of national . wealth Before Entering War Debt charges as percentage of national At End of the War Debt as percentage of national wealth Debt charges as percentage of national income United States Great Britain France Italy Japan Russia* Belgium Total Allied Powers* Germany Austria Hungary Turkey Bulgaria I Total CentralPowers Grand total .... 204,400 69,600 s8,Soo 22,800 ir,7oo 60,000 15,000 3S,300 11.000 6,000 4,000 r.700 6,500 1,300 17-3 16. 1 ro.3 17.6 14-5 10.8 8.7 O.S9 4-97 II. 28 13-29 10.78 8.49 4.81 0.07 1.08 4.20 2.58 3.18 3.35 1.92 13.01 54. 10 52. 13 65.83 10.97 go. 67 12.59 2.53 12.92 32.17 14.43 3 -OS 11.78 6.54 442,000 80,500 23iSoo 16,500 4,O0D 4,000 65,800 10,500 2,400 1,400 500 SOO 14.9 13. 1 10.2 8.5 12.5 12.5 4.83 1.45 11.20 9.71 16.68 4.28 1. 21 0.40 4.21 3.79 9.00 1.60 37.86 49.70 72.64 53.99 50.05 28.95 .8.70 20.96 25.92 24.78 17.60 21.80 128,500 570,500 15,300 81,100 II. 9 14.2 4-8s 4-84 1.63 1.29 53.81 22.01 II. 21 * Eliminating the Bolshevist currency, equivalent to $28,966,000,000, the revised percent- age of debt to national wealth would be for Russia 42.30, for the AlUed Powers 32.30, for all belligerents 37.15 per cent. The percentage of pre-war debt to national wealth was lowest for the United States and second lowest for Germany. Turkey had the highest percentage, and the other countries stood in the following order: Italy, France, Austria, Japan, Hungary, and Russia. The accuracy of these figures in general is indicated by the fact that the percentages of debt to national wealth for the total Allied Powers, for the total Central Powers, and for the grand total of all the countries listed, bear much the same relation to each other as do the figures for the pre-war per capita debt of these groups of nations. The post-war figures for the percentage of debt to national wealth for the two great groups of powers also tally approximately with the per capita debt at the same date. Digitized by Microsoft® 44 INTERNATIONAL FINANCE AND ITS HEORGANIZATION That IS, the relative losses of the two groups of powers as indicated by these tables are consistent. However, a serious error is undoubt- edly involved in a comparison of the post-war national debt and the pre-war national wealth. It is absurd to think that the leading countries of the world have on the average lost over 40 per cent of their national wealth as a result of the war or that individual countries, like Italy, and Great Britain, have lost over 50 per cent. The source of the error undoubtedly is the fact that pre- war national wealth was estimated in terms of stable currency standards and post-war national debt in terms of inflated values. 5. Inter-Allied loans — Both on the origin of the national debt and the after-war problem of liquidating them, the question of inter-Allied loans has a most vital bearing. Up to the early part of 19x9 the financially strong countries had advanced about $22,000,000,000 to the weaker members of their groups. The total foreign debt of Great Britain, France, and Italy was as follows:*' Country Date Approximate amount (in millions) Mar. 31, 1919 Mar. 31, 1919 May 30, 1919 «6s7o S2II 3669 France Italy These governments had in turn loaned to other governments the following amounts: Country- Date Approximate amount (in millions) United States April 1, 1920 Mar. 31, 1919 May, 1919 Mar. 30, 1919 Sept. 1, 1918 $9660 869s 3413 1794 S74 France TaDan ' For details see chapter on Inter-Allied Debts. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 45 Advances by the United States, Great Britain, and Germany, were as follows: Chtef Advances by Belligerents (in million dollars) By United States to— Great Britain 4316 France 3048 Italy 1619 Belgium 343 Russia 187 Greece 48 Czecho-Slovakia. . . 55 Roumania 25 Serbia vj Cuba 10 Liberia 5 By Gteat Britain to — France 170 Italy 2065 Russia 2840 Belgium 435 Serbia go Other allies 240 Dominions 853 By Germany to — Austria and Hun- gary 914 Bulgaria 510 Turkey 370 The repayment of inter-Allied indebtedness depends upon the relative inflation in the borrowing and lending countries, relative taxation and the rapidity of liquidation after the war, the repara- tion payments, and the financial clauses of the treaty. In the origin of inter-Allied indebtedness the considerations were, the need for foreign goods to prosecute the war, the common aim and therefore mutual support in achieving victory, and the extent of the cost to the borrowing and lending belligerents. What the ultimate disposition of these debts is to be is difficult now to say. After the Napoleonic Wars, Britain canceled part of the debts of her allies to her. The cost of policing Cuba during the first decade of the twentieth century is an unpaid obligation of Cuba to the United States. England has already written off 50 per cent of Russia's debt to her. On the other hand, France is insist- ing that Russia repay to the last centime the loans that France extended to her. The disposition of the inter-governmental loans depends upon many factors which will become clearer within the next few years. (c) Taxes — The relative amount of money raised by taxation during the war is of great significance, because it affords an opportunity to verify the opposed theories of war finance advocated by economists. The amount of money which the belligerents, except the United Digitized by Microsoft® 46 INTERNATIONAL FINANCE AND ITS REORGANIZATION States and Great Britain, raised by taxation for the payment ol war expenses was very slight. The after-war condition of the finances of the belligerents vindicates the policy of very heavy war taxation and shows the financial peril which must result from financing chiefly by loans. 1. Ratio of taxes to expenditure — ^The ratio of total taxes to total expenditure was highest in the United States, followed in order by Great Britain, France, Italy, and Germany. If loans to the Allies are excluded as expenditures, the United States raised 36 per cent of the total expenditures by taxes. If, however, we deduct from the total taxes and total expenditures the amounts estimated for normal peace time the position of France would be last, and the relative position of the other countries would remain unchanged. France raised about I per cent of her war expenditures by war taxes. 2. Total taxes and war taxes per capita per annum — During the period of the war the total amount of taxes raised was largest in Great Britain, the other countries ranging- in the following order: United States, Germany, France, and Italy. However, deducting the equivalent of peace-time taxes collected during the war, the surplus of war taxes proper were least in the case of France. The per capita war taxes were highest in Great Britain and lowest in France. The war taxes per capita per annum were also highest in Great Britain and lowest in France. T.MCES Per Capita Per Annum " * Country Period covered see p. 47 yrs. mos. Popula- tion (thou- sands) Total taxes (millions) Taxes per capita Taxes per capita per annum Total war taxes (millions) War taxes per capita War per capita per annum United States Great Britain. . . . : i 4 5 4 " 4 5 io6,6s3 46,089 39,700 36,717 67,8t3 $8,400 11.439 3.998 3.403 4.046 $78.76 348.19 100.70 $35. 00 53.18 32.79 13.31 13. SI I6900 7730 31 IOS9 1713 $64.70 167.73 35.36 $38.75 35. 94 Italy s-87 5-73 Germany "The term war taxes as used in this table refers to the surplus raised over the equivalent taxes of the last peace year. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 47 Summary of Expendituses and Receipis from Taxation During the War (in million dollars) Country Period covered Total revenue Total expendi- ture Loans to co-bel- ligerents Peace taxes during war period Peace expendi- tures during war period United States.. Great Britain.. France Italy April 6, 191 7 June 30, 1919 Aug. 1, 1914 Mar. 31, 1919 Aug. 1,1914 Dec. 31, 1918 Aug. 1, 1914 June 30, 1919 Aug. 1, 1914 Dec. 31,1918 8,400 11.439 3.998 2,403 4,046 32,428 46.38s 25.996 i7,S9S 36.79s 9102 8464 2413 2261 iSoo 3709 3977 1344 2333 1641 4484 4319 2S32 2670 Germany Country War taxes * War expendi- tures " Ratio or Taxes to Expenditdres Total per cent Total exclud- ing loans to allies per cent War Taxes to War Expenditures Total per cent Exclud- ing loans allies. per cent United States Great Britain France Italy Qermany. . . . 6goo 7730 21 IOS9 1713 30.787 41,901 21,677 15.063 34.125 25.8 24.7 iS-4 133 10.9 36.0 30.1 17.0 13-3 11.7 22 4 18.S i.o 7.0 S-o 314 23.1 I.I 7.0 5-4 *The terms war taxes and war expenditure as used in this table mean the surplus over peace figures. The war figures are obtained by deducting from the total figures the figures of the last peace year multi- plied by the number of years of the war period. The column "war taxes per capita per annum" indicates the fiscal effort of the five principal belligerents. It shows strikingly the failure of Germany, Italy, and particularly France, to increase revenue from taxation during the war. The relatively sound position of both the United States and Great Britain after the Digitized by Microsoft® 48 INTKENATIONAL FINANCE AND ITS REORGANIZATION war is due to the fiscal policy which is reflected in the high war taxes per capita per annum levied in these coimtries. 3. SOURCBS OF REVENUE AND RELATIVE INCREASES IN TAXES. a. Direct taxes to total taxes — Before the war the ratio of direct taxes to total taxes was highest in Italy. Her leading allies ranked in the following order: Great Britain, France, and the United States. Other sources of revenue were customs duties and other indirect taxes. As a result of the development of the graded income tax and the excess-profits tax, the ratio of direct taxes to total taxes during the war rose to highest levels in Great Britain, followed by the United States, Italy, and France. In the last year cited in the table below the ratio was 67 per cent in the United States, and 74 per cent in Great Britain, but only 35 per cent in Italy and 32 per cent in France. b. Relative increase in direct taxes — If the direct taxes for the last year of peace be taken as 100, the relative increase in direct taxation was greatest in the United States, followed by Great Britain and Italy. France developed her direct taxation least of the four countries. In the last year cited, as compared with the peace-year standard, direct taxes rose 49 times in the United States, II times in Great Britain, 3.3 times in Italy, and only 14 times in France. c. Relative increase in total receipts — ^Although France and Italy have sources of revenue other than taxation, such as revenue from government monopolies and government enterprises, the revenue from these sources did not increase much, and in some cases not at all. Therefore, in the relative increase in total revenue the United States again showed the highest increase followed by Great Britain, Germany, Italy, and France. In the last year cited, as compared with the peace-year standard, total receipts rose 7.0 times in the United States, 4.5 times in Great Britain, 3.5 times in Germany, 2.5 times in Italy, and only 1.3 times in France. d. The ratio of total taxes to expenditures — Before the war, taxes, direct and indirect, formed the principal source of revenue of the United States and Great Britain, but France, Germany and Digitized by Microsoft® PRmCrPIES AND PRACTICE IN THE WORLD WAS 49 Italy had other sources of national income. Because of the failure to increase taxes adequately, and because of the steady or declining amount of revenue from non-tax sources, the ratio of total taxes to expenditures declined to very low figures in France, Germany and Italy. Sources of Revenue and Relattve Increases in Taxes and Revenue During the War United States (fiscal year ends June 30) 1916 July I, '16- April s, '17 April 6, '17- June 30, '17 1918 r9i9 Ratio of direct taxes to total taxes . . . Ratio of taxes to expenditures Relative direct taxes (1916 — 100), . . . 17.2 100.4 100 zoo 6.6 69.4 27 -3 43.9 1038 331 68.7 26.5 3790 499 67.1 24.3 4950 7or Great Britain (fiscal year ends Mar. 31) I9I4 Aug. I, 'r4- Mar. 3r,*i5 1916 1917 1918 I9r9 Ratio of direct taxes to total taxes . . . Ratio of total taxes to expenditures.. . Relative direct taxes (1914=100) Relative total revenue ^1914=100)... 3r.o 82.7 100 100 44.8 29.2 193 130 45-5 18.7 26r 170 67.8 23. s 692 289 7S.S 22.7 91S 357 73-9 30.4 II4S 448 1913 Aug. z, 'z4- Dec. 3z,'z4 Z9ZS Z9z6 Z9Z7 Z918 Ratio of direct taxes to total taxes . . . Ratio of total taxes to expenditures. . . Relative direct taxes (1913 = 100) Relative total receipts (1913 = 100) . . 29. z 92. z . zoo zoo 3S-6 17.8 74 62 27.9 16.0 IS 79 24.2 IS. 2 26.2 IS. 2 Z07 IZ9 32.3 zs.o r40 127 Z914 OTfi Ratio of direct taxes to total taxes . . . Ratio of total taxes to expenditures. . . Relative direct taxes (1914 = zoo) Relative total receipts (z9z4=ioo) . . 4Z.2 S2.7 zoo zoo 46.0 2S.S Z09 9S Z34 119 4S.S 143 Si.z Z2.6 279 206 35. 4 It. 4 336 246 Germany (year ending Dec. 31) Z9I3 1914 I9IS I9z6 Z917 Ratio of total revenues to expenditures Relative total receipts (z9z3=ioo)... 8Z.8 87.4 zoo 27.8 37.2 106 6.9 6.7 78 7.S 7-3 92 16.2 iS-9 3S3 (d) The Increase in Note Circulation — The direct cost of the war cannot be measured exclusively in terms of loans and taxes. Another factor is the increase of note circulation, whether caused directly by the state itself by printing Digitized by Microsoft® 50 INTERNATIONAL FINANCE AND ITS REORGANIZATION fiat money, as in Russia or in England, or whether it is caused indirectly through the medium of the official bank, as in France, Germany and the other countries of Europe. The increase in the note circulation increases the floating debt of the state, which issues treasury bills in exchange for bank notes, and in addition leads to the depreciation of the currency. It is theft by the state. Capitalists and holders, through bonds, of the accumulated wealth of the country are subjected to a capital levy, as it were, the rate of which is equal to the depreciation of the purchasing power of money. The recipients of current wealth in fixed amounts, as in wages and in salaries, are robbed by the same process. An invisible income tax is placed upon them, and the rate is equal to the depreciation of the currency. Who gets the money? The owners of war industries, the stockholders or proprietors, retain the untaxed portion of profits, which is created by the insistent war-time demand for commodities. The nation as a whole is neither richer nor poorer as a result of the increase of note circulation, just as in the case of an increase in domestic debt. However, in both cases, the owners of war industries are enriched at the expense of the wage- earning, salaried, and bondholding classes. The note circulation of the principal belligerents increased all the way from 3.5 times in the case of Japan to 47.0 times in the case of Russia during the war. Before the war, the per capita 'note circulation of the various countries ran in the following order: France, Belgium, Italy, Greece, Austria-Hungary, Germany, United States, Bulgaria, Great Britain, Russia and Japan. After the war, the series ran: Russia, France, Austria- Hungary, Germany, Belgium, Bulgaria, Italy, Greece, Great Britain, Turkey, United States, Japan. The rate of increase was greatest for Turkey, followed by Russia, Austria- Hungary, Ger- many, Bulgaria, Great Britain, Italy, Greece, France, United States, Belgium and Japan. Such conclusions as may be drawn from these figures should take into account the financial habits of the people, the use of metallic or paper currency before the war, and the use of checks rather than either kind of currency. This table covers the absolute increase in paper money as a factor in the direct cost of the war. It does not deal with the ratio of metal to paper, which will be treated in the section on currency and credit. Digitized by Microsoft® PKINCIPLES AND PRACTICE IN THE WORLD WAR Note CiRCtrLAiiON of Principal Belligerents (in million dollars) SI Before Entering War At a Recent Date Country Date Note circulation Date Note circulation Ratio 1919 Total Dollars per capita Total Dollars per capita 1914 Allied Powers ; United States. . . . Great Britain .... July I, I9J4 July 29, 1914 July 30, 1914 July 31, 1914 Aug. 31, 1914 Aug. 4, 1914 Mar. 19, 1914 July 31.1914 71S 223 1290 S18 842 186 46 6.70 4.84 32.49 14. II 2.81 4.62 24.29 9.29 Oct. 1, 1919 Oct. IS, 1919 Oct. 16, 1919 July 20, 1919 Sept. 6, 1919 Oct. 1, 1919 Oct. 9, 1919 Aug. 27, 1919 3,523 2,333 7,102 2,964 567 '39,762 906 2S8 33.03 so. 62 178.89 80.73 9.78 218.2s 118. 31 52.12 4.92 10.4s S.51 5-72 3.48 5.60 Italy Belgium Total 3983 S38 432 36 8.26 7.93 8.2s 0.42 6.52 57,415 10,066 9,294 704 475 IIS -65 148.44 177.47 33.09 86.10 14.42 18.6s 21.56 78.22 Central Powers: Germany Austria-Hungary . July 23,1914 July 23,1914 July, 1914 Sept., 1913 Sept. IS, 1919 Sept.. 30, 1919 April, 1919 June 14, 1919 Total lois 4998 6.91 7.9s 20,539 77,954 139.7s 121. 16 Grand total. . . . 15.6 iii. Indirect Costs of the War The cost of the war cannot be reduced to terms of bonds, taxes and increase in the note circulation. Of the intangible items, no appraisal can be made. However, the economic items of cost would include the destruction of the accumulated wealth of the past, and the loss of current production. The indirect costs have been estimated ** as equivalent to the direct costs. In other words, the total direct and indirect cost of the war would be about $370,000,000,000. Of course, this would rule out the mere transfer of territory, property, or reparation payments, which con- stitute a national loss but not a world loss. (a) Loss of Life — The loss of life in the World War is estimated to be 12,991,000. This figure includes the known dead and an estimated 50 per "^ Edgar Crammond. The Cost of the War. Journal of the Royal Statistical Society, May, 1915, p. 398. Digitized by Microsoft® 52 INTERNATIONAL FINANCE AND ITS REORGANIZATION cent of those listed as prisoners or missing. The distribution by countries is given as follows by Bogart: Casualties of the World War (in thousands) Country Known dead Seriously wounded Otherwise wounded Prisoners or missing United States Great Britain France Russia Italy Belgium Serbia Roumania Greece , Portugal Japan Total Allied countries Germany Austria-Hungary Turkey Bulgaria Total Central Powers Grand total 107' 807 1428 2758 S07 267 707 339 IS 4 43 618 700 1000 SCO 40 322 200 10 S t 148 1,441 2,344 3.9SO 462 100 28 t 30 12 I S 6S 4S4 2500 1359 10 100 116 4S 6939 1611 911 437 loi 3438 1600 850 108 300 8,si6 2,183 2,150 300 852 4654 773 443 104 II 3060 9999 2858 6296 5,486 14,002 1330 5984 These figures agree substantially with those of the French War Office. Economiste Frangaise, January 4, 1919, p. 9. * Includes deaths in camps in United States and abroad. Actual casualties were about 58,000. Bogart, idem. t Included in preceding column. The loss of life during the Napoleonic Wars from 1792 to 181 5 was about 2,000,000; during the American Civil War, about 700,000; and during the Balkan War, about 500,000. The total loss of life in wars of the nineteenth century was about 4,500,000. The known dead of the World War was five times that of the Napoleonic Wars, which lasted 23 years, and twice that of all the wars of the last century. Bogart translates the loss of life into monetary terms, using the estimates by several statisticians of the value of a human life. The values range from $400 up to $10,000 and by using an arithmetical average of seven estimates the figure Digitized by Microsoft® PRINCIPLES AND PRACTICE IN T^E WORLD WAR 53 $45 > 899.000,000, is obtained as the capitalized value of the lives lost. In addition to the deaths resulting from military operations, the decrease in births reduced the civilian population by 500,000 in the United Kingdom, 833,000 in the uninvaded district of France, 2,600,000 in Germany, and 2,600,000 in Austria-Hungary. To the loss of life must be added various degrees of incapacity on account of wounds or sickness, directly ascribable to the war, as trench fever, Spanish influenza, and tuberculosis. Again, as a result of famine and hardship, the vigor of the populations was reduced. (b) Loss of Property — The loss of property is as difficult to determine as the capi- talized value of the loss of life. Estimates vary, depending upon the authority and whether they were made for the purpose of increasing the indemnity under the treaty or of obtaining credit for reconstruction. For instance, the property losses in Belgium have been figured to be from $6,750,000,000 to $8,000,000,000. Bogart accepts the figure $7,000,000,000. The official appraisal of Belgium wealth, published in 19 13 by the Finance Minister of Belgium was $5,905,000,000. J. C. Stamp has revised this figure upward and takes $7,500,000,000 to be a liberal estimate. On either of these bases, the claims at the peace table and the Bogart figures are obviously too high. Keynes estimates as a maximum a physical loss of $750,000,000 and levies and requisi- tions of $500,000,000.^^ The estimates of property loss in France submitted at the Peace Conference were similarly overrated. M. Loucheur, Minister of Industrial Reconstruction, estimated that the cost of rehabilita- tion of the devastated areas would be about $15,000,000,000. M. Dubois, of the Budget Commission of the Chamber of Deputies, set $13,000,000,000 as a minimum, excluding war levies, losses at sea, loss of public monuments and roads. M. Klotz, Minister of Finance, estimated the total French claims for damage to property at $26,800,000,000. On the other hand, Rene Pupiii estimates the property losses of the invaded regions at $2,000,000,- 000 to $3,000,000,000. J. M. Keynes, representative of the British "Keynes, J. M,, Economic Consequences of the Peace, 1930. Pp. 184, 127. Digitized by Microsoft® 54 INTERNATIONAL FINANCE AND ITS REORGANIZATION Treasury at the Peace Conference, independently estimated the loss to be $2,500,000,000, about one-sixth of M. Loucheur's figures and less than one-tenth of M. Klotz' figures.'" Bogart summarizes the total property loss at $29,960,000,000, which probably is 50 to 75 per cent too high an estimate. The total loss of tonnage, according to Bogart, was 15,398,000 gross tons, of a value of about $3,000,000,000. (Lloyd's Register of Shipping gives figures as 14,224,000 gross tons.) At a pre- war valuation of cargo at $250 per ton, the total cargo loss would be $3,800,000,000. Total losses at sea therefore would equal $6,800,000,000. (c) War Relief— The total collections for war relief are not avaflable. How- ever, Bogart gives the following figures: $625,000,000 in the United States, about $92,000,000 in Canada, about $87,000,000 in Great Britain, and $69,000,000 in the British Colonies. The total of the known figures is $873,000,000 and the probable total for the entire world is probably over $1,000,000,000. (d) Losses of Neutrals — As a result of the war, the neutrals were subject to immeasur- able hardship, which cannot be reduced to monetary terms. Directly, the cost of the war to them included the expense of mobilization and other outlays incidental to the war. According to Bogart, these costs were as follows: Netherlands, $672,000,000; Switzerland, $250,000,000; Sweden, $430,000,000; Norway, $130,000,000; Denmark, $90,000,000. The total cost of the war to neutrals, including an estimated allowance of $200,000,000 for those not mentioned above, would be about $1,750,000,000. (e) Loss of Current Wealth — This item is practically impossible to determine. The diversion of natural resources to war, the changes in trade routes, the shut- ting off of sources of income, the increased expenditure of human effort, and the decrease in consumption, cannot be estimated. Bogart assumes that 20,000,000 men were withdrawn from industry for 4j^ years. Allowing an average productive capacity of $500 per year, the total loss of production would be $45,000,000,000. "Keynes, ibid. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 55 However, this estimate does not take account of the increase in production due to the removal of the restrictions on output during the war, the replacement of men by women in industry, and the vastly greater production of goods during the war than either before or after the war. (f) Social Unrest — An important element in the cost of the war is the loss of production following its close. The productivity of mines, fields and factories declined not only below the war-time levels but even below the pre-war levels. And the end is not yet. The intangible cost of the readjustment to some sort of stable conditions after the war is an indirect cost of the war. (g) Total Indirect Costs — Excluding the last item, Bogart summarizes the indirect costs as follows: Capitalized value of human life: Soldiers (In millions) $33,500 33,500 30,000 6,800 45,000 1,000 Civilians Property losses: Land ShiDoin? and carso War relief 1,700 151,500 Except for the three minor items, loss to neutrals, war relief, and loss of shipping and cargo, these items are subject to a possible reduction of about 50 per cent. (h) Compensation — The offsets to the direct and indirect costs of the war are both economic and political. Some of the expenditures were incurred for productive ends, as the building of plants, railroads, ports and ships, which would have been built in the normal course of development. Again, some of the costs are apparent rather than real, such as the provisioning of the military and civilian population by the state instead of from private funds. The average Digitized by Microsoft® S6 INTERNATIONAL FINANCE AND ITS REORGANIZATION increase in the index numbers of wholesale prices during the period 1914-18 was more than 100 per cent over the 1913 figures, so that the total cost of the war would have to be reduced by 50 per cent to obtain a pre-war valuation. The ultimate conversion of the debt and the reduction of the rate of interest may reduce the money cost considerably. In addition to these offsets, there are positive economic gains. The war stimulated large-scale production, the use of automatic machinery, the development of efficient methods of industrial organ- ization. New processes were developed, like the Haber method of making artificial nitrates. Some substitutes were developed whose production may become profitable if prices of the original article in use should rise. The war thus developed potential re- straints on high prices of some commodities. In commerce, new and more efficient methods of international distribution of com- modities were made practicable during the war and may remain permanently after the war. In the larger sense, the war must be regarded merely as an incident in the development of the human race. All our political and social gains in the past have been achieved at a price. Some ambitious sociologists and statisticians have attempted to estimate the money cost of progress and to compute in terms of lives the cost of social gains like those resulting from the French Revolution. The per capita cost of the Russian Revolution, it is said, is less than that of the French Revolution. However, should the League of Nations be tested, the world at large will adopt the Anglo-Saxon method of achieving progress, by counting heads instead of breaking them. When the world at large will be able to compel social change without violence, the cost of progress in terms of lives will be greatly reduced. If the World War results in an effective and just League of Nations, perhaps the gigantic cost will be more than compensated by the infinite gains in the method of social development. Digitized by Microsoft® CHAPTER II BRITISH PUBLIC FINANCE^ A. Pre-War Situation and Cost of the War After the Napoleonic Wars, the British debt was reduced out of the occasional annual surplus of budget revenue instead of by payments into a fictitious annual sinking fund. The interest rates on the outstanding debt were lowered by successive conversions of 'Material in this chapter is based on the following sources: Official sources: Finance accounts of the United Kingdom. (Annual in Sessional papers.) Statements relative to the national debt. (Annual in Sessional papers.) Statements of revenue and expenditures as laid before the House by the Chancellor of the Exchequer when opening the budget. (Annual in Sessional papers.) Votes of credit. (Annual in Sessional papers.) Reports of the Committee on currency and foreign exchanges after the war. (Lord Cunli£Fe, Chairman.) Interim report, 1918. Final report, 1919. (This and other special financial reports may be found in Sessional papers.) Hansard's Parliamentary Debates (speeches of Chancellors of the Exchequer, Lloyd George, 1914-15; McKenna, 1915-16; Bonar Law, 1917-18; Austen Chamberlain, 1919 — ) Report of the Commissioners of internal revenue. (Annual in Sessional papers.) Report from the Committee of Public Accounts. Return Relating to Imperial Revenue (Collection and Expenditure). (Annual in Sessional papers.) Account of the Public Income and Expenditure. (Annual in Ses- sional papers.) National Debt and Assets. (Annual in Sessional papers.) Inland Revenue. (Annual in Sessional papers.) Semi-official sources: Journal of the Royal Statistical Society. Economist. (London.) Statist. Bankers' Magazine. (London.) Stock Exchange Official Intelligence. Stock Exchange Yearbook. 57 Digitized by Microsoft® S8 INTERNATIONAL FINANCE AND ITS REORGANIZATION portions of the debt from 5 per cent to 3 J4 per Tent in the period 1822-1834, and to 3 per cent by 1853. As a result of the Crimean War, the anticipated reduction of interest rates to 2j4 per cent was not accomplished. In 1875, the government made provision for definite sinking fund instalments instead of utilizing chance budget surpluses to redeem the debt. Under this scheme, large reductions were made in the first decade in the twentieth century. To con- vert all the 3 per cent loans, a new stock was issued in 1888 to yield 2^ per cent until 1903 and 2^ per cent thereafter for twenty years. The great increases in debt were due to wars. The Napoleonic Wars added 613 millions sterling to the debt and hardly 59 millions were paid off before the Crimean War. The latter added another 35 millions which was paid off in the following twelve years of peace. The Boer War added 163 millions sterling to the debt and only 90 millions was paid off at the outbreak of the World War. The great increase in the recent years before the war in the civil budget, covering extensions of social legislation, interfered with the rapid reduction of the debt. In spite of the criticism of students of public finance and of statesmen of Great Britain, her debt was handled with greater skill than the debts of the Con- fer collateral reading: Bogart, E. L., Direct and Indirect Costs of the World War. New York: Oxford University Press, 1919. Kirkaldy, A. W., Labor, Finance and the War. London: Sir Isaac Pitman and Sons, Ltd., 191 6. Kirkaldy, A. W., Industry and Finance. London: Sir Isaac Pitman and Sons, Ltd., 1917. Laughlin, J. Laurence, Credit of the Nations. New York: Charles Scribner's Sons, 1919. International War Loans of the Belligerent Countries. New York: National City Company, 1918. Seligman, E. R. A., The Cost of the War and How it Was Met American Economic Review, ix. 4; 739-770, December, 1919. Gottlieb, L. R., Indebtedness of Principal Belligerents. Quarterly Journal of Economics, xxxiii, 3: 504-531, May, 1919. Debts, Revenues and Expenditures and Note Circulation of the Prin- cipal Belligerents. Quarterly Journal of Economics, xxxiv, i: 161-205, November, 1919. Les Finances d'Apris Guerre, Revue de Science et de Legislation Financiires, October, 1920; xviii, 4: 613-713. J4ze,_ Gaston wrote a series of articles during the war in this maga- zine covering official data on war finances. Snodgrass, K. H., British Finance During the War. Federal Re- serve Bulletin, May, 1921, pp. 563-572. Digitized by Microsoft® BRITISH PUBLIC FINANCE 59 tinental countries. In the 99 years between the end of the Napoleonic Wars and the beginning of the World War, the debt had been reduced from 861 millions to 708 millions sterling, or by 18 per cent, and the annual charges from 32.6 millions to 24.5 millions or by 35 per cent. An important characteristic of British financing of the war was the high and increasing ratio of total revenue to total expenditure. As the war progressed, an increasing portion of the war burden was borne by taxation. In the fiscal year 1916, revenue was about 21 per cent of expenditure and in 1919 about 33 per cent. The following table illustrates these facts: Ratio of Revenue to Expendittjees (in millions sterling) Expenditures Amount Revenues Loans Amount Fiscal year Amount Per cent of Expenditures 191 2-13 1914-1S 1915-16 1916-17 1917-18 1918-19 Total war years Less 5 normal years. . 188.6 560 1569 2198 2696 2579 9592 943 188.8 226 336 573 707 889 2731 944 100.1 44-3 21.4 26.1 26.3 33-2 28.4 100.1 20.7 80.4 "9-5 334 1233 1625 1989 1690 6862 Net war total 1919-20 1920-21 8649 166s 1184 1787 1339 1418* 326 234* *Tlie returns for 1920-21 almost yielded the surplus of about 234 millions sterling estimated. As the war progressed Britain raised increasing funds through taxation. A vigorous tax policy in turn strengthened British credit during the war. Digitized by Microsoft® 6o INTERNATIONAL FINANCE AND ITS REORGANIZATION B. Loans A classification of the forms of the public debt of Great Britain from 1914 to 1919 indicates several pronounced tendencies. As the war dragged on, loans from new sources increased so that in the fiscal year ending March 31, 1919, about 28 per cent of the outstanding public debt was obtained from sources not used before the war. The drain on the old sources of public credit compelled a shift to new sources. Furthermore, in the early stages of the war, short-term loans constituted the chief reliance of the treasury; but in the later stages of the war long-term loans were more extensively used. After America entered into the war, Britain had less need to resort to short-term domestic borrowing, as the United States government advances then became available. The following table shows the above mentioned facts : Outstanding Public Debt of Geeat Britain Classified at Given Dates* (in million pounds) Aug. 1, 1914 Mar.31, 191S Mar.31, 1916 Mar.31, 1917 Mar.31, 1918 Mar.31, 1919 Increase 1919 over 1914 Old sources: Long term Short term .... 616.3 37-0 960.4 144.6 1307-4 743-8 2386.9 784.0 3134-7 1365-1 4104.4 1349-6 3488.1 1312.6 Total old sources .... New sources: Long term Short term .... 653 3 1105.0 2051 . 2 , 62.0 19.9 3170.9 466.0 217-S 4499.8 1148.9 192.3 5454 -0 1614-S 456.5 4800.7 1614-S 456 -S Total new sources "Grand total all sources 653-3 1105.0 81. 9 2133 -i 683.5 3854-4 1341-2 5841.0 2071.0 7525-0 2071.0 6871.7 *Later figures are given -weclcly in the London Economist The significance of these figures becomes more obvious when the table is given on a percentage basis : Of the total increase in the public debt, about 70 per cent was obtained from old sources and about 30 per cent from new sources; Digitized by Microsoft® BRITISH PUBLIC FINANCE 6i about 75 per cent was in long-term loans and about 25 per cent in short-term loans. Aug. 1, Mar.31, Mar.31, Mar.31, Mar.31, Mar.31, Increase 1914, 191S, 1916, 1917, 1918, 1919, 1919 over 1914, per cent per cent per cent per cent per cent per cent per cent Old sources: Long term Short term .... 94.3 S-7 86.9 131 61.4 34.8 61.9 20.3 S3- 7 233 S4-S 17.9 SO. 8 19. 1 New sources. Long term Short term .... 0.0 0.0 0.0 0.0 2.9 0.9 12. 1 5-7 19.7 33 2I-S 6.1 23-S 6.6 Total from— Old sources 100.0 100. 96.2 82.2 77.0 72.4 69.9 New sources. . . 0.0 0.0 3.8 17.8 23.0 27.6 30.1 Total in- Long term Short term .... 94.3 5-7 86.9 131 64- 3 35- 7 74.0 26.0 73.4 26.6 76.0 24.0 74.3 2S-7 The total debt outstanding on November 30, 1920, was ^7735-6 millions equivalent to $37,620 millions at parity. In reply to an interpellation in the House of Commons, the Chancellor of the Exchequer gave the details of the national debt as follows:" Form of debt Amount in millions sterling Funded debt (2I per cent, consols, etc.) Terminable annuities 3|-per cent, war loan, 1925-1928 4|-per cent, war loan, 1925-1945 S-per cent, war loan, 1929-1947 4-per cent, war loan, 1929-1942 4-per centfunding loan, 1960-90 4-per cent. Victory bonds Exchequer bonds, 1920, 1921, 1922, 1925, and 1930. 4- and 5-per cent, national war bonds Treasury bonds, 5-15 year Treasury bills Ways and means advances National savings certificates Other debt (chiefly foreign debt) 3150 18. 5 62.7 12.8 1949- 3 67.2 407.0 3S7-7 3150 1441.0 13-8 iiii-S 222.6 277.9 "63s Total. 773S-6 'House of Commons debates, Dec. 9, 1920 and Dec. 16, 1919. See also statement of National Debt and Assets, Mar. 31, 1920. (Cmd. 780.) Digitized by Microsoft® 62 INTERNATIONAL FINANCE AND ITS REORGANIZATION The distribution of the debt by maturities is given elsewhere in this chapter. i. Ways and Means Advances The net increase in Ways and Means Advances from August I, 1914, to March 31, 1919, was £455,500,000. The net advances each year were as follows: Fiscal year Millions sterling 1915-16 1916-17 1917-18 1918-19 Total 18.9 197.6 25.2* 264.2 455 -S * Decrease for the year. Ways and Means advances were credits on the books of the Bank of England. They were used when credit was needed promptly, and were retired when treasury bills were issued or when war loans were floated. ii. Treasury Bills The treasury bill was utilized as a fiscal device in Great Britain and at the declaration of war there were about £10,000,000 of treasury bills outstanding. The old pre-war system of tendering for bills was discontinued and in its place rates of discount were adjusted to produce the supply of short-term funds needed by the government. Treasury bills ran for three, six, nine and twelve months, and were discounted by the Bank of England and the joint-stock banks. Before the war, banks were the chief pur- chasers. During the war private investors bought them extensively. As the war continued, increasing amounts of treasury bills were issued so that in September, 1918, about £1,000,000,000 were out- Standing. As the outstanding amounts increased, the volume be- came unmanageable and interest rates rose; and as a measure of expediency successive war loans were issued to reduce the volume of treasury bills. Digitized by Microsoft® BRITISH PUBLIC FINANCE 63 The floating of long-term loans was rendered necessary because of the fact that the rates on treasury bills had increased so as to make the long-term loan the more economical and less un- manageable form. Treasury bills were accepted in payment of war loans so that for example between December of 19 16 and April, 1917, there was a reduction of over £600,000,000 in treasury bills, of which about £130,000,000 was used for subscrip- tion to the loan. The sale of treasury bills, which had been dis- continued in 1916, was resumed in March of 19 17 on the old pre- war system of tender. During the fiscal year 1917-18, treasury bills were used extensively; about £500,000,000 net were issued. In the fiscal year 19 19, there was a net decrease in the amount of treasury bills outstanding. To the investor, the advantage of treasury bills lay in the fact that they were a convenient investment for temporarily idle funds. Their liquid character made them practically the equivalent of cash. To the Government, the treasury bill was a quick means of securing funds. On the other hand, the disadvantage of treasury bills was that they matured at short intervals and con- stituted a serious refunding problem when the volume outstanding became very great. The net issue of treasury bills was as follows: Fiscal year ending March 31 Millions sterling (increase) 191S 1916 1917 1918 1919 Total 61.7 489.6 103 . 1 decrease 509-7 , 16. 4 decrease 941 -S The decreases in 19 17 and 1919 were due to the fact that more bills were retired than were issued. In 191 9 the Drummond- Fraser plan of continuous borrowing made it unnecessary to resort to treasury bills. War expenditure certificates were treasury bills running for two years. They were issued in 191 7 to the extent of about £23,- 600,000, but were completely retired in the following two years. Digitized by Microsoft® 64 INTERNATIONAL FINANCE AND ITS REORGANIZATION iii. Exchequer Bonds Like treasury bills, exchequer bonds were a tested fiscal device before the World War. They had been used during the Crimean War and the Boer War. The bonds were issued as follows: Fiscal year ending March 31 Millions sterling 191S 1916 1917 1918 1919 Total 46.9 109.6 143.3 714 0.9 372.1 The issue of 1915 had been put out at 3 per cent, but during 1916, the rate was raised to 5 per cent, and subsequently to 6 per cent. The terms ran from three to five years. The increase in rate was intended to deflect new money from the short-term treasury bills into the longer-term exchequer bonds. Indeed, the rates on treasury bills in 191 6 were reduced for this reason. Furthermore, the high interest rate on exchequer bonds was de- signed to attract foreign capital and thus to stabilize exchange. As an inducement to subscribe to exchequer bonds, they were made receivable at their nominal value in payment of excess-profits taxes and of inheritance taxes. Furthermore, they were receivable at their face value as cash for subscription to war loans. During the fiscal years 19 18 and 19 19, when the plan of continuous day-to-day borrowing was practiced, exchequer bonds were issued to a less extent than during the earlier years of the war. iv. Long-Term Bonds Great Britain issued six war loans. The first loan was issued at 95 and bore 3j^ per cent interest. It was dated March i, 1915, was redeemable in 1925 and matured in 1928. The amount raised was £340,600,000. The second war loan was issued at par, bore 4j^ per cent interest, was dated June i, 1915, was redeemable in 1925 and due in 1945. '^^ amount raised was £576,600,000. Digitized by Microsoft® BRITISH PUBLIC FINANCE 6$ The third war loan was issued in two forms. The taxable bonds were issued at 95, with 5 per cent interest rate, dated June I, 1917, redeemable in 1929, and due in 1947. The tax-exempt bonds were issued at par, bore 4 per cent interest, and matured in 1942. The cash raised was £962,200,000, most of which was in the taxable form. The fourth war loan was also issued in both tax-free and a taxable form. The tax-free bonds were sold at par, bore 4 per cent interest, and matured in 1927. The taxable bonds were sold at par, bore 5 per cent interest, and matured in five, seven, and ten years. They were issued continuously after October i, 191 7, under the Drummond-Fraser plan of day-to-day borrowing. The 1918-19 National War Bonds were also sold continuously under the Drummond-Fraser plan, the advantages of which were that interest was saved on idle borrowed funds and that subscrip- tions were stimulated out of savings rather than out of borrowings at the banks. The sixth war loan was issued on February i, 1919. Again, there were two forms, a 5 per cent taxable bond and a 4 per cent tax-exempt bond. The issue and redemption prices were the same as on the former loan, which were redeemable at a slight premium above par. The seventh war loan of 5-15 year treasury bonds was issued in the spring of 1920 for the sole purpose of repaying the floating debt consisting of treasury bills and Ways and Means advances of the Bank of England. The treasury bonds were issued con- tinuously under the Drummond-Fraser plan, and in order to fund the floating debt the new bonds were to pay a rate of interest i per cent higher than the annual average treasury bill when the average rate was from 5J^ to 6j^ per cent, and 2 per cent higher when the average rate was 6j^ per cent or over. After 1925, the rate of 5 per cent goes into effect and holders may demand repayment at par upon one year's notice. The bonds are due in 1935 and redeemable by the government after 1925 upon specified notice. Aside from the perpetual debt and the 4 per cent loan maturing i960 to 1990, maturities of the British war bonds range up to 1947- The national debt reached a high figure of £8079 million on January i, 1920, and was reduced by £237 million during the calendar year to £7842 million. The budget for the fiscal year Digitized by Microsoft® 66 INTERNATIONAL FINANCE AND ITS REORGANIZATION ending March 31, 1921, had a surplus of £230 million which was applied to the further reduction of the debt. About £30 million of long-term bonds were retired out of the statutory sinking fund. (a) Inducements to Subscribe — Subscribers to the first loan had the privilege for three years of borrowing at the Bank of England up to the issue price of the bonds. In the second loan, payments were accepted in 3j^ per cent consols at 66%, slightly above the then existing market price. Furthermore, holders of the second loan had the right to convert into future loans, issued at a higher rate. Subscribers to the third loan were offered a choice of a taxable or a tax-exempt bond. Holders of the fourth war loan had the privilege of converting their bonds into the third war-loan bonds. As a further induce- ment to subscribe, in connection with the third war loan one- eighth of one per cent a month was set aside to maintain the market price of the bonds. Finally, most of the war loans of Great Britain were issued below par, the total loans of about £5,200,- 000,000 par value being issued at an average price of 96.45, and the National War bonds being payable at a premium of two, three, and five points, depending upon the term of the bond. (b) Control of Capital Issues — I. Procedure — ^The control of new issues of capital by the British government under conditions accepted by the stock ex- changes in the United Kingdom, began when the London Stock Exchange was reopened in January, 19 15. By the terms of this agreement the Cowimittee of the Stock Exchange bound the mem- bers, under penalty of expulsion, to certain regulations approved by the British Treasury. Under the regulations affecting new issues of capital, no dealings were to be allowed on the stock exchanges in any new securities unless the issue had been first approved by the Treasury. The procedure adopted by the committee was to deal with the cases involving smaller amounts in summary fashion and to refuse applications for new issues unless a good case had been made out, either (a) that the new issue was essential to the prosecution of the war or (b) that the refusal to approve the new issue would involve a heavy or an entire lose of previously expended capital. After a transition period covering the year 191 5, no new issues Digitized by Microsoft® BRITISH PUBLIC FINANCE 67 of any sort except for renewal purposes were approved unless they were essential for the prosecution of the war. With regard to the question of capital expenditures or borrowings by the local or municipal authorities in Great Britain, it was urged upon the officials to preserve capital and labor in the country for the prosecu- tion of the war and to defer capital expenditure.' 2. Effects — ^The effect of these restrictions was to curtail very greatly the total volume of capital issues. Taking the total for the year 1913 as a base of 100 the issues in 1915 were 34 per cent, in 1916 14 per cent, in 1917 11 per cent, and in 1918 27 per cent. That is in four years, 1915 through 1918, the total new securities issued were only 86 per cent of the issues in the single year 191 3. The restrictions on issues during the war resulted in very large issues after the war. The issue of new securities in Great Britain since 1911 is given herewith. British government loans are ex- cluded. New Capital Issued by Years * Year In million pounds Relative figures, 1913 figures as 100 1911 igiz 1913 1914 191S 1916 1917 1918 1919 1920 192 207 242 200 83 26 6S 238 384 79 86 100 82 34 14 II 27 98 IS9 'Memorandum of Basil P. Blackett, Esq., Secretary of the Capital Issues Committee of Great Britain (subsequently financial advisor of the British Embassy), addressed to James F. Curtis, Secretary of the New York Federal Reserve Bank, Aug. 6, 1917. This was submitted in the testimony of Vice-governor Warburg in the hearings before the Senate Committee on Finance, Feb. 8, 1918, on S. 3714, "A Bill to Create a War Finance Corporation." Submitted also before the Committee on Ways and Means of the House, Feb. 19, 1918, on H. R. 9499. ' London Joint City and Midland Bank Circular, January, 1931. For detail classification see article, Capital Issues in 1920. Statist, January 8, 1921, p. 50. Digitized by Microsoft® 68 INTERNATIONAL FINANCE AND ITS REORGANIZATION V. War Savings Certificates These were issued for the small investors through thousands of associations, formed to encourage purchase on the installment plan. The total amount sold, chiefly during the latter part of the war, was over two hundred millions sterling. They were tax exempt and were issued in several denominations. vi. Foreign Borrowings The course of British public finance was from short-term to long-term loans, both domestic. When the demand for goods out- ran the supply of domestic credit, Britain turned to the United States and with difficulty raised in the open market an unsecured loan. Subsequently, loans secured by collateral were sold to private investors and finally, when the United States entered the war, government credits were advanced by the United States to her allies. (a) Unsecured Loans — In conjunction with France, Great Britain proposed to float a $1,000,000,000 bond issue in the United States. The unfamiliarity with foreign securities on the part of the American investor led the mission which arranged the loan to reduce the amount to $500,000,000. The loan was dated October 15, 191 5, and was due October 15, 1920. It was issued at 98 and bore 5 per cent interest. A syndicate of 288 financial institutions underwrote the issue. This was an unsecured loan, the largest foreign loan ever placed in the United States, and the largest single issue since the Civil War, and therefore not a complete success. The British Government also raised an unsecured three-year loan in Japan in December, 1916, equivalent to £10,000,000 at 6 per cent. The proceeds of the loan were devoted to the purchase of dollar balances in America which were held on Japanese account. (b) Treasury Bills — By means of treasury bills, funds can be obtained without the elaborate preparations that precede the floating of a long-term loan. After the war had been waged for two years, it became increas- ingly difficult to secure credit in Great Britain for the purchase of Digitized by Microsoft® BRITISH PUBLIC FINANCK 69 supplies in the United States. Two secured loans had been placed since the unsecured loan of October, 191 5. Further credits were needed, and for this purpose British treasury bills were placed in the United States. In November, 1916, the Federal Reserve Board cautioned its member banks against locking up their funds in obli- gations of foreign governments which were short-term in form, but either by contract or force of circumstances might have to be re- newed continually and thus constitute, in reality, a long-term obligation. After the United States entered the war, military considerations outweighed banking expediency. On August i, 1917, the British government, through J. P. Morgan & Company, its fiscal agents, floated 60 and 90 day dollar treasury bills in the New York markets. Up to November 11, 191 8,, the date of the armistice, the maximum outstanding amounted to $84,405,000. The rate rose from 5 per cent to 6 per cent. (c) Mobilization of Securities — The mobilization of American securities held in Great Britain was effected for the purpose of stabilizing foreign exchange rates. In 191 5 insurance and trust companies in Great Britain were re- quested to sell or lend specified American securities to the Treasury. "A scheme setting forth the conditions under which the securi- ties would be purchased or accepted on loan was published. "i. Purchase — ^The Treasury imdertook to purchase any suitable dollar securities, at prices based on current New York Stock Exchange quotations, the sterling price to be paid being cal- culated at the exchange of the day; in the case of no reliable quotation being available, the price was to be fixed by agreement. "2. Deposit on Loan — Securities loaned to the Treasury were to be accepted for two years from the date of deposit, on the understanding that the interest received on such securities would be paid to the depositor together with an additional payment at the rate of one-half of one per cent per annum on the nominal amount of the security. . . . Owners had the option to release securities so deposited or they could be sold on behalf of the de- positor, the understanding in each case being that the equivalent value in sterling at the exchange of the day should be paid in London." *» **R.eport of the American Dollar Securities Committee, Nov. ao, 1919, submitted to the House of Commons. Digitized by Microsoft® 70 INTERNATIONAL FINANCE AND ITS REORGANIZATION The appeal to the holders did not produce American securities in sufficient volume, and the Treasury thereupon resorted to coer- cion and in May, 191 6, levied a special tax of 10 per cent on the income derived from all issues which were eligible for purchase or loans, and which were not surrendered. As the depreciation of exchange became increasingly difficult to check, further coercion was resorted to and the British Treasury was empowered to com- mandeer eligible securities and to place restrictions upon holders. Upon relinquishing control of dollar securities in April, 19 19, more than 1,800 issues of stocks and bonds of American origin had been surrendered. If sterling, franc, krone, and florin bonds be included, the total number of securities was 2027. The aggregate of all securities mobilized was £622,595,000, of which £216,644,000, or about 35 per cent, were purchased, and £405,951,000, about 65 per cent, were loaned. The American securities mobilized totaled £250,543,000, of which £177,614,000, or 70 per cent, were purchased by the Treasury and £72,929,000, or 30 per cent, were loaned to the Treasury. The American securi- ties mobilized were 40 per cent of the total amount. Of the loaned securities, the American were about 18 per cent in amount. Of the purchased securities, the American were about 82 per cent in amount. (d) Secured Loans — As a result of the mobilization of securities, Great Britain floated a loan for $250,000,000, secured by collateral valued at about $300,000,000, dated September i, 1916, and maturing Sep- tember I, 19 1 8. The bonds bore 5 per cent interest, were under- written at 98, and sold at 99. The loan was a success. At maturity it was paid off from the proceeds of the sale of the collateral. In October, 19 16, a second loan secured by collateral was placed in the United States. The par amount of the loan was $300,000,000, and it was dated November 1, 1916. One-half of the loan was in the form of three-year notes, and the other half in the form of five-year notes. The prices were 99J4 and 985^ respectively, and the rate of interest 5j^ per cent. The half of the loan maturing in 1919 was refunded by the issue of $250,- 000,000 of 5j^ per cent three-year notes and ten-year bonds, offered at 98 and 96J4 respectively, and both convertible into national 5 per cent War Bonds at a rate of exchange fixed at $4.30. The half maturing in 1921 was paid off. Digitized by Microsoft® BRITISH PUBLIC FINANCE 71 The last of the series of loans raised by Great Britain in the United States during the period of American neutrality was floated on February i, 1917. American and foreign securities con- stituted the collateral. The total issue amounted to $250,000,000, divided into $100,000,000 of one-year notes and $150,000,000 of two-year notes. The rate of interest was 5J^ per cent, and the issue prices were 99.52 and 99.07 respectively. The notes were convertible at the option of the holder into 5j4 per cent bonds of the United Kingdom, due in 1937. The $100,000,000 due in 1918 was paid off, and $143,587,000, practically the balance of the issue, was converted. The total amount of British loans sold privately in the United States was $1,050,000,000. (e) The Financial Impasse — By the spring of 191 7, the burdens on the British Treasury were becoming difficult to bear. During the fiscal year ending March 31, 191 7, the treasury bills floated amounted to about £1,790,000,000, as compared with about £500,000,000 during the previous fiscal year and a similar amount for the following fiscal year. Britain was finding the task of financing herself and her allies from domestic credit sources almost impossible. It was becoming increasingly difficult and dangerous to British bank credit to export gold. Unsecured loans in the United States were not popular, and securities to be used as collateral were limited. The seriousness of the situation is described by J. M. Keynes, representative of the British Treasury at the Peace Conference: "The financial history of the six months from the end of the summer, 19 16, up to the entry of the United States in the war in April, 1917, remains to be written. Very few persons, outside the half dozen officials of the British Treasury who lived in daily contact with the immense anxieties of impossible financial require- ments of those days, can fully realize what steadfastness and courage were needed, and how entirely hopeless the task would soon have become without the assistance of the United States Treasury." **> (f) United States Government Advances — Upon the entrance of the United States into the war. Great Britain's financial problem of finding credits for herself and her *The Economic Consequences of the Peace, footnote on p. 273, American Edition. Digitized by Microsoft® 72 INTERNATIONAL FINANCE AND ITS REORGANIZATION allies was solved. The United States extended credits to Great Britain, and through her as well as directly made advances to the Allies. The first advance made by the United States to Great Britain on April 25, 191 7, amounted to $200,000,000. The rate of in- terest was 3 per cent per annum until June 30, 191 7> and 3j^ per cent thereafter until such time as the United States had to pay a higher rate to her own bondholders. Up to June 15, 1920, the United States government advanced to Great Britain about $4,277,000,000, which was about 45 per cent of the total cash advances made to foreign governments by the United States, and about 12 per cent of the total indebtedness of Great Britain at the end of the war. (g) Loans to Allies and Dominions — The loans to the British dominions and to Britain's allies offset the British borrowings in the United States. As of March 31, 1920, the total British loans amounted to about £1,850,000,000, or about 22 per cent of the total borrowings, domestic and foreign. Great Britain's Loans to Allies and Dominions * Loans to Allies to March 31, 1920 In million pounds Per cent of total Russia '. 568.0 S14.8 455-3 97-3 20.9 66.6 8.0 30-6 27-9 24.6 5-3 Italy Belgium Serbia 36 0.4 Relief loans Total , 1731.1 51.6 29.6 19.4 15-8 3.1 935 1 It Loans to Dominions Australia New Zealand I 6 1.0 0.9 South Africa Other deoendencies Total 119. 5 1850.6 6.5 Grand total • Budget speech of Austen Chamberlain. Digitized by Microsoft® BRITISH PUBLIC FINANCE 73 The Chancellor of the Exchequer estimated that in normal years the British government's receipts from interest on its loans will balance the interest on its borrowings from the United States gov- ernment. But as a matter of fact the loans to Dominions and Allies are being carried at 50 per cent of their face value. Even at that figure, it is doubtful whether the loans and borrowings of Great Britain will offset each other, either in the payment of interest, or in the re-payment of the principal. (h) Total Foreign Borrowings — On March 31, 1919, the British foreign debt was £1,364,- 850,000 and by March 31, 1920, it had been reduced to £1,278,- 714,000. Advances by the United States government, equivalent to about £880 million, constituted the largest item in the British foreign debt; private borrowings in the United States ranked next, and borrowings in Canada ranked third. Like her investments, British borrowings were world-wide — in Europe, North and South America, Asia and the islands of the Pacific. During the year the reduction of £86 million resulted from the repayment of the British share of the Anglo-French loan, and part of the £150 million advances by Canadian banks. Payments were also made to Norway, Sweden, Switzerland and Holland. External Debt of Great Britain ' (in millions sterling) Countries United States Canada Japan Argentina Uniguay Netherlands Sweden ^ain Fiji Straits Settlements Mauritius Sundry Allies Total Maturity Amounts Sundry Sundry Sundry 1046.8 73-4 7.2 1921 19.2 1921 6.0 1920 0.7 1921 1928 0.8 2.S 1920 Sundry 0.4 7-7 1922 °S "35 1278.7 'House of Commons Paper, 144. Returns of the external debt as of March 31, 1919, and 1920, showing the external debt, the due date and the arrangements for repayment. H. M. Stationery Office, August, 1920. Digitized by Microsoft® 74 INTERNATIONAL FINANCE AND ITS REORGANIZATION C. Taxes (i) The Taxation Policy — In general, the taxation policy of Great Britain during the war was greatly to increase her direct taxes and to rely on a limited number of sources of revenue. The British tax policy was not the result of experimentation in a wide field, such as prevailed on the Continent. The exception to this principle was the development of the munitions-profits tax and the excess-profits tax. In the fiscal year 19 14, the income tax, the chief direct tax, produced about 24 per cent of the total tax revenue, in 19 16 about 38 per cent. After the fiscal year 191 7, the two direct taxes, the income tax and excess-profits tax, produced over 60 per cent of the total revenue from taxation, direct or indirect. The non-tax revenues declined, as might have been expected. They were not capable of expansion pari passu with the tax revenues. The slogan, "Business as Usual," prevalent in England during the early part of the war, made it difKcult to curb civilian consumption by restrictive taxa- tion. Luxury taxes were introduced late in the war. Britain's tax policy reflects sound economic thinking. The total revenue in 1919 was 4.5 times as great as in 1914. The tax revenue in 191 9 showed an even greater increase over 1914, 4.84 times. The revenue from the income tax in 1919 was 6.17 times as great as in 19 14 and that from the combined income and excess-profits tax in 1919 was 12.20 times as great as the revenue from the income tax in 1914. The indirect taxes did not increase to the same extent. The customs revenue in 1919 was only 2.98 times as great as in 19 14 and the excise tax only 1.50 times as great. Non-tax revenues in 1919 were 2.97 times as great' as in 1914. The distribution by percentages of taxes for the years 1914 to 1 91 9 is shown herewith: Source 1914 Per cent 191S Per cent 1916 Per cent 1917 Per cent 1918 Per cent 1919 Per cent Income tax Excess profits Total tax 239 82^2 17.8 30.6 83.5 16. s 38.1 86.1 139 3S-3 24.4 89.7 10.3 33-9 311 86.7 13.3 32-7 321 88.2 11.8 Non tax revenues. . . Grand total rev- enue 100. 100.0 100.0 100,0 100.0 100.0 Digitized by Microsoft® BRITISH PUBLIC FINANCE 75 Throughout the war, there was a continuous increase in the actual revenue, and leaving out of consideration the year 191 5, when the expenditures were rather low, a continual increase in the ratio of revenues to expenditures and of the ratio of taxes to expenditures. The revenues collected in the fiscal years ending March 31 were as follows: Year Millions sterling 1914 1915 1916 1917 1918 1919 Total, 1915-1919 . 197.2 226.7 336.8 S73-4 707.2 888.8 2930.1 The important items of revenue, during the war are given by fiscal years ending March 31, on page 76. ii. Direct Taxes Direct taxation produced over 60 per cent of the total tax revenues after the excess-profits tax came into full effect in the fiscal year 191 7. In the first two years of the war the income tax, which was the chief direct tax, brought in an increasing per- centage of the total tax revenue, and rose from 29 per cent in 1914 to 36 per cent in 191 5 and 44 per cent in 1916. The munitions levy (subsequently abandoned), and the excess- profits tax were the sole new sources of direct tax revenue. The increase in the amount of direct-tax revenue was due in part to a continuous raising of the rates of old taxes and in part to the intro- duction of the new tax. (a) Income Tax — In the first war budget in the fall of 191 4 the rates on the income tax were doubled. In the following fiscal year the normal tax rate was increased and the exemption limit was lowered from £160 to £130. Furthermore, supertaxes from lod. to 3s. 6d. were levied on incomes of £2,500 to £10,000. Unearned incomes, so called, were taxed more heavily than earned incomes. In the fiscal Digitized by Microsoft® 76 INTERNATIONAL FINANCE AND ITS KEORGANIZATION year 1916-17 there was a further increase in fates, the minimum being as. 3d. on incomes between £130 and £300 when earned, and 3s. on unearned incomes, and a rate of 5s. in the pound applying on incomes over £2,500. There was no change in the supertax above this sum. But in the fiscal year 1918-19 the supertax was raised to from IS. to 4s, 6d. in the pound. There were no further increases in the rate on incomes under £500. SotTRCES or Revenue in Great Britain During the War' (in million pounds) Source 1914 191S 1916 1917 1918 1919 Ratio of 1919 to 1914, per cent Tax Revenues: Customs 34-3 39-6 27.3 47.2 36.6 42.3 28.4 69.4 59-6 61.2 310 128.3 70. S 56.4 31.2 205.0 139.9 71.2 38.8 31-9 239. S 220.2 102.8 59-4 30.2 291.2 285.0 298 Excise Estate duties Income tax, etc Excess profits Stamps, land tax, house duty and other minor taxes * III 617 Total tax revenues . Non-tax Revenues: Postal service Miscellaneous Telegraph and tele- phone, Crownlands, Suez Canal, etc.*.. 162.0 21.2 2-3 189.3 20.4 S-9 290.1 24.1 9.8 514.^ 24. 3 16.5 613." 25.2 52.^ 784.1 29.4 523 484 139 2270 Total non-tax rev- 3S-2 37-4 46.7 59. 3 94.2 104.7 297 Grand total 197.2 226.7 336.8 573. 4 707.2 888.8 4SO • Not specified. The yield of the income tax was £47.2 million in the fiscal year 1914, £69.4 million in the fiscal year 1915, £128.4 million in the fiscal year 1916, £205.0 million in the fiscal year 1917, £239.6 million in the fiscal year 1918, and £291.2 million in the fiscal year 191 9. ' Finance Accounts of the United Kingdom, annual House of Commons paper. Digitized by Microsoft® BRITISH PUBLIC FINANCE 77 (b) Excess-Profits Tax— This tax was the principal innovation in British tax policy and proved to be a fruitful source of revenue. The British excess- profits tax was a tax on war profits, that is on profits in excess of the average profits of ariy two of the three pre-war years. It bore no relation to invested capital and was simpler to calculate than the American excess-profits tax. It was introduced in the budget of September, 1915. The rate for the period August i, 1914, to July I, 1915, was 50 per cent of the excess over the pre-war standard. In the fiscal year 19 16-17 the rate was increased to 60 per cent and as a result the returns exceeded the estimates by over 50 per cent. In the fiscal year 191 7-1 8 the rate was further in- creased to 80 per cent. In the first budget after the war the rate was reduced to 40 per cent and in 1921 finally abolished.* The yield on the excess-profits tax was about £140 million in the fiscal year ending March 31, 1917, £220 million in the fiscal year 1918, and £285 million in the fiscal year 1919. iii. Indirect Taxes Indirect taxes did not bring increased revenue to as great an extent as did direct taxes. The rates on the old taxes, customs and excise, were increased and a few new indirect taxes were levied. (a) Customs and Excise Taxes — In the first war budget of David Lloyd George the duty on tea was raised from 5d. to 8d. per pound and the duty on beer was raised from 7s. 9d to 25s. per barrel. In the fiscal year 1916 the budget of Reginald McKenna raised the indirect taxes by increas- ing the rates by 50 per cent on tea, cocoa, coffee, tobacco and other articles of general consumption and by 100 per cent on gaso- line and patent medicines. In the fiscal year 1916-17 the existing rate on sugar was raised 50 per cent, on tea and coffee 100 per cent, and on cocoa 300 per cent. In the fiscal year 1917-18 the rate on tobacco was raised. The tax on most other commodities was left unchanged. In the fiscal year 1918-19 the increase in taxation was obtained chiefly from indirect taxes. The direct tax rates seem to have reached the limit of productivity. The rate on beer, matches and gasoline was doubled, the rate on sugar was raised from lis. 8d. •Address of Austen Chamberlain at Birmingham, Feb. 3, 1921. Digitized by Microsoft® 78 INTERNATIONAL FINANCE AND ITS REORGANIZATION to 2SS. 8d. per hundredweight, and the rate on tobacco was raised from IS. to 8s. 2d. per pound. (b) Consumption and Luxury Taxes — Although every tax is repressive to some extent and the customs and excise taxes did tend to check consumption, several specific taxes were levied with the aim not so much of producing revenue as of curtailing the use of non-essential goods. The?; were, how- ever, introduced rather late in the war. They were levied on articles that had been free from taxation. In the fiscal year 1916 an import tax of 33j^ per cent was levied on motor cars, motor- cycles, musical instruments, and cinema films. In the fiscal year 1917 the so-called luxury tax was extended to include admission to theaters, moving pictures and outdoor sports. In the fiscal year 191 8 a very high tax was levied on dogs newly acquired and the tax on dogs already owned was increased, with the prime purpose of checliing their consumption of food. In the fiscal year 1918-19 a luxury tax such as was in effect in the United States was levied on two classes of commodities, (i) outright luxuries such as jewelry, perfumes, pianos, yachts, etc., the tax on which was applied regardless of the price, and (2) semi-luxuries such as clothing, meals and lodging at clubs and hotels, etc., which were subject to tax only when the price exceeded specified figures. (c) Non-Tax Revenues — The non-tax revenues did not constitute a large percentage of the total revenues. They were not capable of expansion to the extent that the tax revenues were. In 19 14 they constituted about 18 per cent of the total revenue and in 1919 about 12 per cent. In the fiscal year 1916 the rates on postal, telegraph and telephone service were increased and in the fiscal year 1919 postal rates were further increased and a stamp tax on checks was levied.* D. Problems of the Post-War Budget The post-war budget bristled with difficulties. The magnitude of the debt-service charges, the problems of reducing military and civil expenditures, of maintaining the returns from the income and ' For full discussion see speeches of Austen Chamberlain and interpella- tions, House of Commons Debates, April 30, 1919, cols. 175 et seg. Digitized by Microsoft® BRITISH PUBLIC FINANCE 79 excess-profits taxes, of balancing the budget, of meeting the deficit, and of handling the floating debt, — these were a few of the diffi- culties that faced the head of the Treasury. i. Comparison of Pre-War and Post-War Budgets The budget for 1920-1921 called for a revenue 7.5 times as large as the budget for 1912-1913 and the revenue in the supposedly normal post-war budget set up by the Chancellor of the Exchequer would be about 4.3 times as large. In setting the hypothetical budget for a normal year the Chan- cellor of the Exchequer made no allowance for interest on ad- vances to the British government by the United States. The normal budget is based on the assumption that the interest due to Great Britain will offset the interest due by Great Britain. On the $4,277,000,000 owed to the United States, the annual interest debit will be about £42,000,000. This assumption is open to question. Budget Figures for 191 2-13, Compared with Estimates for 1920-21 AND A Normal Post-war Budget '" (in thousand poimds sterling) I 91 2-13 1920-21 Normal Post-war Year Items Amount Per cent Rela- tive figure Amount Per cent Rela- tive figure Amount Per cent Rela- tive- figure Revenue Customs and excise . . Inland revenue Post office lull 29,17s 4,874 37-9 44.1 155 2.S 100 100 100 100 348,650 686,500 53,000 330,150 3-7 23-3 488 182 6760 290,000 460,000 43,000 13,000 36.0 S7.0 50 2.0 406 148 266 Non-tax revenues. . . Total revenixes. . . . ExPENTDIinSES Consolidated fund. . . Army and navy serv- iee l8S,8o2 37,018 72,436 51,944 27,224 100. 19.6 38.4 27-5 I4-S 100 100 100 100 100 1,418,300 376,198 230,429 497,318 80,157 lOO.O 31.8 19-4 42.0 6.8 75° lois 318 960 294 8o6;ooo 373,000 135,000 246,600 53,400 ICO.O 46.0 17.0 30.0 7.0 427 1008 i36 Revenue and p<^- ofl&ce service 475 196 Total expenditures. 188,622 100. 100 1,184,102 100. 630 808,000 100. 42S "Hansard, April 30, 1919, cols. 119, 120, 141. See also memorandum presented by the Chancellor, October 23, 1919, Cmd. (376, 377), revised in Cmd. (379)- London Economist, July 3, 1920, p. 8, and April 24, 1920, p. 856. Digitized by Microsoft® 8o INTEKNATIONAL FINANCE AND ITS REORGANIZATION The above table shows some striking facts. A comparison of the items of budget revenue shows that inland revenue constituted the chief source of revenue in each of the three years, before the war, immediately after the war and during a normal post-war year. This consisted of income and excess-profits taxes chiefly, and to a less extent of inheritance and stamp taxes, the land tax and house and land-value duties. Customs and excise constituted the second largest source of revenue during each of these three years. Of the expenditures in the budget the army and navy service represented the largest percentage of any item in the pre-war budget. In 1920-21 the civil service represented the largest per- centage of expenditure, and in a normal post-war year the consoli- dated fund services will constitute the largest percentage of expendi- ture. The lowest item of expenditure in each of the three years is the revenue and postoffice service. The next smallest item of expenditure is in the pre-war year, the consolidated-fund service, and in the after war years the army and navy service. In fact the army and navy service in 1920-21 as well as in the normal post- war year constitutes so small a percentage of the total, 19 per cent and 17 per cent respectively, that even a substantial reduction in the army and navy service will not afford any decided help in the problem of balancing the budget. Unless revenue can be materially increased, and this is doubtful, the chief economies will have to come out of the largest item ; the service of the debt may be reduced by refunding at a lower rate of interest. The civil-service expenditures may hardly be curtailed. Among the largest items are education, science, art, postofHce, and pensions and insurance. Few of these can be greatly reduced. A comparison of the relative figures in the table, in which the 191 3 figures have been taken as a base of 100 shows that on the revenue side the largest increase was in inland revenue, chiefly from the income and excess-profits taxes. The customs and excise taxes show the second largest increase, chiefly on a limited range of com- modities. The increase in non-tax revenues is without significance, as the heavy increase for 1920-21 was due to the sale of miscel- laneous war assets. On the expenditure side of the budget, by far the largest increase is in the service of the debt. The second largest increase is in the civil service. Digitized by Microsoft® BRITISH PUBLIC FINANCE 8l ii. Meeting the Deficit (a) Extent and Cause of the Deficit — From the fiscal year 19 15 through the fiscal year 19 19 Great Britain met by revenue about 28 per cent of her total expenditures. That is, there was a deficit of about 72 per cent in the five war budgets. Domestic and foreign loans bridged the gap between receipts and disbursements. In the fiscal year 1919-20 the expendi- tures were £1,665,773,000 and the revenues only £1,339,571,000, leaving a deficit of £326,202,000, or nearly double the total cost of government before the war. This deficit would have been £622,633,000, almost twice as great, but for the fact that the sale of war supplies and other non-tax revenues yielded £296,431,- 000. In 1912-13 the budget practically balanced. In 1919-20 the receipts were 38 per cent short of expenditures. In 1920-21 there was estimated a deficit of only £95,952,000 or 8 per cent of expenditures which was to be more than covered by sales of war supplies and by other non-tax revenue totaling £330,150,000, leaving an estimated net credit balance of £234,198,000 for the reduction of the debt, which at the end of the year was actually a budget of £230,557,000 surplus. The cause of the deficit for 1919-20 was said by Mr. Chamber- lain to be the continuance of military expenditure as a consequence of the delays in the establishment of peace. Again large expendi- tures for the fiscal year 1920 were incurred on account of subsidies for bread, coal, and the railways. The bread subsidy cost about £56,000,000, the coal subsidy about £32,000,000, and the railway subsidy about £53,000,000, a total of about £141,000,000 for the year. These charges represented concretely the cost to the Govern- ment of financing the war by inflation, and were as properly a war cost as interest on the debt. Other factors contributing to creating a deficit were the large expenditures on pensions and higher pay for the army and navy, as well as unemployment doles and other after-war expenditures. The party of the opposition criticised the use of money from the sale of war stores to balance expenditures. These stores were purchased with borrowed funds and the salvage money should have been credited to the debt and not to the revenue account. The use of these funds in the budget was compared to "the sale of one's furniture to pay the rent." Digitized by Microsoft® 82 INTEXUSfATIONAL FINANCE AND ITS REORGANIZATION (b) Wiping Out the Deficit — To meet the deficit is was necessary to increase revenues and decrease expenditures. A special companies' profits tax of i shilling in the pound, that is 5 per cent, was to be levied on the profits of limited liability companies. Other increases in taxes aflEected gasoline, alcoholic liquors, and cigars and there is to be a lowering of the limit of income at which super-taxes become effective. Minor changes in taxation covered stamp taxes, telegram, telephone, and postal rates. In addition to broadening the basis of taxation and increasing the volume of revenue the Exchequer plans to effect economies such as the revision of railroad rates so as to make the railroads self-supporting, and the elimination of the bread subsidy and the unemployment doles.^^ The temporary expenditures arising out of the war such as land-settlement loans, railway deficits, donations to ex-soldiers for training, education, resettlement, and unemploy- ment, and other small items, amounted to £182,000,000. In 1920- 21 there have been reductions from the 1919-20 expenditures of about £374,000,0000 for army and navy services and about £72,- 000,000 for the civil service. The 1920-21 budget as compared with the 1919-20 budget shows a reduction of 29 per cent in expenses, from £1,666,000,000 to £1,184,000,000, and an increase in revenue of 6 per rent from £1,340,000,000 to £1,418,000,000. As a result the deficit of £326,000,000 in 1919-20 was converted into a credit balance of £234,000,000. iii. Maturing and Floating Debt Although British financing in the war was sound and conserva- tive (about 25 per cent of the loans were short-term and 75 per cent were long-term), the question of handling the floating debt is a serious one. At the end of the year 1919 about £1,500,- 000,000 of the British debt was due within the year. The budget for 1920-21 was expected to have a balance of about £234,000,000 available for the reduction of the debt. "Report of Select Commitee on National Expenditures for 1920. House of Commons papers, 113, 142, 168, 238, 245. Digitized by Microsoft® BRITISH PUBLIC FINANCE 83 The classification of the public debt by maturities follows: National Debt of Great Britain as of December 31, 1919 (in million pounds sterling) Per cent of grand total Due within one year: Ways and Means advances Treasury bills Exchequer bonds Anglo-French loan Victory bonds Total Due within five years: Exchequer bonds Victory bonds Annuities War savings certificates Debt in United States Debt due to United States Government . . . Other debt due foreign nations and dominions Total Due in five to sixty years; Exchequer bonds Victory bonds National war bonds War loans Debt in United States Funding loan Total Perpetual: Annuities for life and term of years Consols Debts due to Bank of England Debts due to Bank of Ireland Total Miscellaneous: Other capital liabilities Grand total 245.2 1106.6 160.3 Si-4 S-o 1566.5 146.4 20.1 8.2 267.3 .48.5 867.4 329.8 1687.7 16.6 334-4 1508.8 2X22.6 60.0 409.x 4451 S XX. 8 301 -4 II. o 2.6 326.8 46.2 8078.7 19-39 20.89 SS-M 4.04 O.S7 100.00 Digitized by Microsoft® 84 INTERNATIONAL FINANCE AND ITS REORGANIZATION The Treasury attempted to reduce the floating debt at the time of the issue of the Funding Loan and Victory Bonds in 1919. The nominal amount offered was £575,000,000. Of the total the banks subscribed £110,000,000. Hartley Withers pointed out the difficulty of handling the floating debt after this attempt at funding it. In a pessimistic mood he said "the funding operation has been an almost complete failure and the only prospect that appears to lie before the government is one of continuing to finance by treasury bills or ways and means advances or by any other kite-flying method by which they can appear to make both ends meet." The floating debt must either be funded or paid off. At present it can be funded only at a high rate of interest, for only the reduc- tion in the floating debt makes it possible to reduce the rate of interest. Unless the government has a surplus of revenue over expenditure, the alternatives are either to issue new treasury bilk to meet those maturing or else to resort to further inflation through ways and means advances. The sound way of liquidating the floating debt is to raise cash either through taxation or through the sale of war savings certificates. The continued sale of war savings certificates, the Drummond-Fraser plan of issuing bonds con- tinuously in small lots, may offer a solution to the problem of handling the floating debt. Such a solution would be sound because it would involve continued saving by the people, the only method by which the fiscal problems of the belligerents may be met. The Treasury bonds sold in 1920 were aimed to fund the treasury bills. They were to bear y^ per cent higher rate than the bills, until 1925, but only 5 per cent thereafter, and were redeemable by the holder upon one year's notice. At the end of April, 1921, an attempt was made to refund maturing National War bonds by means oi a 3)4 per cent Con- version loan maturing in 196 1 and convertible at the rate of £166 per £100 of National War bonds. In spite of the high yield offered, about 5.7 per cent, for 40 years, the funding scheme was a failure. Of £632 million of War bonds maturing by Septem- ber, 1923, which had the option of conversion, only £148 million were offered up to the beginning of June, 1921, an amount hardly sufficient to retire the £198 million of National War bonds matur- ing October i, 1922. On July 5, 1 92 1, the Chancellor of the Exchequer offered for sale "on tap" and without limit as to amount, a new issue of 5j^ Digitized by Microsoft® BRITISH PUBLIC FINANCE 8$ per cent Treasury bonds at 97, maturing April I, 1929, and con- vertible up to October i, 1922, at par into £146 of 3^ per cent Conversion loan. The results were unsatisfactory. By August 3, 1921, only £89 million of new Treasury bonds were issued in ex- change for National War bonds and Exchequer bonds, £52 mil- lion only of the latter being converted out of a total of £72 mil- lion, maturing October, 1921. In the words of the editor of the Statist, "If the new loan proves a failure, and if current expenditure is not drastically reduced, we may expect an increase in Treasury bills and Ways and Means Advances during the current financial year of something like 200 millions. "12 E. An Appraisal of British War Finance In the light of the experience of the belligerents it is possible to appraise the theories of war finance advocated by economists and the policies followed by the several governments. The standards by which the policies of war financing are to be judged relate to the difficulty in raising funds, the need for changing the fiscal policy, the distribution of the burden with respect to ability to pay, and the outlook for the future. i. Availability of Funds Great Britain was able to finance her allies as well as herself. Her financial policy made it possible to lend to her co-belligerents 22 per cent of the total amount of the British debt at the end of the war. As an offset the borrowings from the United States Government were only 11 per cent of the total British war debt. British credit held out for almost three years until America assumed the burden of the weak Allies. (a) Moderate Rise of Interest Rates on War Securities — As the demand for funds increased, interest rates rose. In 1914 treasury bills were sold at a yield of 3^ per cent and in 1915 the rates ranged from 2^ per cent for three-months bills to 3% per cent for nine-months bills. In 1916 treasury bills were offered not at a fixed published rate but on the old competitive or "Statist, April 30, June 4, July 9, and August 6, 1921, pp. 740, 1037, 42 and 228. Digitized by Microsoft® 86 INTERNATIONAL TINANCE AND ITS REORGANIZATION tender basis and the rates were approximately 4^ to 5 per ccnt.^' In 1917 when the fixed rate basis was restored, the rates ranged from 4^ per cent on three-months bills to 4j^ per cent on nine- months bills. The rates on exchequer bonds increased likewise. In 1 9 14 3 per cent exchequer bonds were sold on the system of tendering to yield 3.18 per cent. In 19x5 the fixed rate was 5 per cent. In 19 16 the rate was raised to 6 per cent in order to deflect new money from treasury bills to longer term exchequer bonds. The rise in the rates on exchequer bonds caused the decline in the quotations of all outstanding securities. In 191 7 the rate was lowered to 5 per cent.^* The rates on long-term loans rose with the increase in the volume outstanding and the demands for funds continuous. The first loan in 1914 was issued at 95, at a rate of interest of 3j4 per cent and a yield of 4 per cent. In 1915 the second loan was put out at par, and at a rate of interest of 4j^ per cent. In 1916 the taxable form of the loan was issued at 95, at a rate of interest of 5 per cent and a yield of about 5.34 per cent. The 19 1 7 loan was put out at par and at a rate of interest of 5 per cent, but payable at a premium so that the yield was about 5.36 per cent. This, the fourth war loan, was issued under the Drum- mond-Fraser plan of continuous borrowing. The tax-exempt issues of the third and fourth loans were issued at par and at a rate of interest of 4 per cent. The foreign loans placed in 191 5 and 191 6 in the United States were issued at around 98, bore interest at 5 per cent, and yielded 5.5 per cent. The last private foreign loan placed in the United States, in 191 7, bore interest at 5j^ per cent and yielded 6 per cent. The proof of the soundness of British war finance lies in the fact that the rate of interest for funds did not rise greatly. The restriction on new capital issues was an important factor but secondary to the strength of British credit in keeping down the rates of interest. The slight premiums upon redemption of the loans and the slight discount at issue were not indications of weakened credit but merely convenient means of increasing slightly the yield of the bonds. With the exception of the United States, Australia, New Zealand and India, which issued war bonds exclu- " Industry and Finance, p. 246, "Ibid., p. 250. Digitized by Microsoft® BRITISH PUBLIC FINANCE 87 sively at par, the belligerents either sold bonds at a discount or agreed to redeem them at a premium. This practice should not at all be taken as an evidence of impaired credit. After America entered the war British credit was strengthened so that the terms of the sixth war loan were not more favorable than those of the preceding. It carried no higher price of issue or of redemption than the previous loans and in addition purchasers were deprived of the privilege of converting into past or future war loans. (b) No Lottery Loans Issued — Although some of the belligerents in financial straits resorted to lotteries to raise money, Great Britain maintained her traditions of strength. The proposal had been agitated during the war and was referred to a select committee of the House of Commons in 1918. The proposal was to issue a 4 per cent tax-exempt loan of which the subscribers would receive 2^ per cent in interest and the other ij^ per cent would be put into a pool from which would be drawn prizes ranging from £1 to £1,000. British publicists were in decided opposition to the plan. They con- tended that the bonds would be a national investment with regard to five-eighths of the interest and a lottery with regard to the rest, and that the Lottery Act in effect for one hundred years would have to be repealed or suspended, and that the British Chancellor of the Exchequer would become a lottery manager, and the Treasury would be converted into a gambling house. "As if the gambling spirit were not rife enough in the country the state would foster it by giving it the seal of its approval and would carry on an active propaganda to urge all classes to join the speculation. It would encourage people to get rich not by work but by hazard and it would urge them to accept its offer on the ground of patriotic duty. It is not surprising that the chair- man of the War Savings Committee bitterly denounced the pro- posal as the destruction of the work on which his vast organization was engaged." ^° The proposal was defeated in the House of Commons on De- cember I, 1919, by an overwhelming vote, 276 to 84. '"Samuel, Herbert. The Plight of the Taxpayer. Contemporary Review, December, 1919. Digitized by Microsoft® 88 INTERNATIONAL TINANCE AND ITS REORGANIZATION ii. Fiscal Policy Unchanged Throughout the War One test of a policy of war finance is the necessity of abandon- ing it when it breaks down. The experiences of the United States in the War of i8i2 and in the Civil War and of France and of Germany in the World War were evidences of wrong fiscal policies. Great Britain, however, adhered to a defined and fairly consistent policy throughout the war. A large percentage of her expenses was met by taxation. The loan policy involved the use of ways and means advances, that is, loans from the Bank of England, when funds were needed quickly. Treasury bills running for a few months and exchequer bonds running for a few years were Used to refund ways and means advances. They were also used in anticipation of long-term loans, the preparations for which lasted months and therefore compelled the use of short-term funds in the interval. Finally when long-term loans could not be raised at favorable terms, treasury bills were sold at home and abroad with intention of renewing them at maturity. The floating debt con- stitutes an embarrassing problem, for bills often mature when money is tight and must be renewed at rising rates. Foreign loans were raised in the United States, Japan, Argentina and elsewhere from 191 5 onward throughout the war. The utilization of the credit reserves of the United States upon her entry into the war relieved the British treasury of the need to resort to open- market borrowing at ever-increasing rates. Taxation was vigorous and increasingly heavy throughout the war. Not only was the interest on loans fully covered, but a large percentage of the war expenditures was met out of taxation. The percentage of taxes to expenditures increased from 1916 through 1919. Direct taxes constituted the chief source of funds. These are democratic in character and not easily shifted. The income and excess-profits taxes produced over 60 per cent of the total tax revenues. The number of sources of tax revenue were few. The rates on most of these were gradually and continually raised throughout the war. A notable change in the tax policy was the introduction late in the war of luxury and consumption taxes the purpose of which was primarily to repress non-essential consump- tion, rather than to raise revenue. Digitized by Microsoft® BRITISH PUBLIC FINANCE 89 iii. Democratic versus Militaristic Finance The British policy was characterized not only by financial prudence but also by political sagacity. The heavy reliance on taxes reduced the evils of inflation w^hich bear most heavily upon the class living at the margin of existence, earning just enough to maintain life. The vigorous tax policy prevented the cost of living from rising rapidly in England as it did in the countries that used loans or note issues more extensively, such as France, Germany, and Italy. Direct taxes, the income and excess-profits tax, are not easily shifted and can be adapted to bear in accordance with the capacity to pay. Britain used these chiefly. The Continent relied on indirect taxes, which raised the cost of living because they were shifted to the consumer. In their incidence indirect taxes usually press most heavily upon those least able to pay. With conspicuous political sanity, the British did not neglect taxation in the hope of an indemnity as the Germans did or in the hope of complete reparation for damages as the French did. Britain fol- lowed a politically democratic and an economically self-reliant tax policy, IV. The Outlook (a.) A Retrospect — It may seem alarming that the expenditures of the six years from April i, 1914, to March 31, 1920, £11,268,000,000, were greater than the expenditures of the 226 years from 1688 to 1914, which amounted to £10,944,000,000. However, an historical comparison is reassuring. The English public debt in 1727 was £52,000,000, in 1817, £839,000,000, and in 1919 £8,078,000,000. In the 90 years preceding the close of the Napoleonic War the English public debt increased 15.65 times and in the 102 years prior to the end of the Word War it increased only 9.62 times. The World War led to a tremendous increase in the public debt. But so did the Napoleonic Wars. The first ten years of the Napoleonic Wars caused an expenditure greater than the 51 years of peace of the preceding century. And the second 15 years of the Napoleonic Wars occasioned an expenditure twice as great as the 51 years of peace which prevailed during the period from 1698 to 1792. Digitized by Microsoft® 90 INTERNATIONAL FINANCE AND ITS REORGANIZATION Expenditures op the Napoleonic Wars and of the Century Precedinq '• (in million pounds sterling) Period Peace War Years Number of years Amount spent Number of years Amount spent 1698-1701 1702— I 7 14 Peace 4 25 "6 9 7 iS-i 142. 5 39-6 89 .i 116. 2 13 10 II 10 Wars of Ann. , 08.8 1715-1739 1740-1749 1750-1755 1756-1766 1767-1775 1776-1785 I 786-1 792 Peace Spanish-Austrian Wars. Peace 9SO Seven Years' War IS9S American War 218.0 Total... SI 402.6 44 10 IS S7I.3 454- 805.0 I 793-1802 First part of Napoleonic Wars 1803-1817 Second part of Napoleon- ic Wars A comparison of the wealth and debt of Great Britain at the end of the Napoleonic Wars and at the beginning of the World War will indicate the probable outlook after the World War. In a century the population of Great Britain increased 2.7 times and the national wealth increased 5.3 times. In spite of three wars during the nineteenth century the debt of Great Britain at the beginning of the World War was only 0.84 as great as at the end of the Napoleonic Wars. The national income in the century following the Napoleonic Wars increased 5.2 times and debt charges decreased to 0.77 of the amount at the end of the Napoleonic Wars. During the World War the British public debt increased about elevenfold and the debt charged increased about twelvefold. The difierence between the changes in the public debt and in the debt charges is due to the fact that in the century following the Napoleonic Wars refunding operations reduced debt charges faster than the debt and during the World War the rise of interest rates increased the debt charges more rapidly than the debt. " Hirst, F. W., Credit of the Nations, pp. 19, ao. See also Fisk, Harvey E., English Public Finance, p. 38. Digitized by Microsoft® BRITISH PUBLIC TINaNCE 91 Wealth akd Debt of Great Britain Date Popu- latun, millions National wealth, million dollars National debt, millioQ dollars Debt per capita. Dollars Debt as percent- age of wealth per cent Relative Figures {1817 figures = 100) Popu- lation National wealth National debt At end .of Napo- leonic Wars (r8i7).... ...... At beginning of World War (1914) At end of World War (1919) 17 46 46 13,100 69,600 69,600* 4,130 3,4S8 37,657 243 30 75.03 817.04 31 -S 4.97 54. 10 100 270 270 100 S30 S30 100 84 911 * It is assumed that the pre-war and post-war wealth are the same, that the new plants erected are equivalent in value to property destroyed. F. W. P. Lawrence in his Levy on Capital, p. 41, assumes a net loss of about 10 to 15 per cent. Harvey Fisk in his English Public Finance, p. 37, assumes that the wealth of Great Britain increased 66 per cent during the war. TMs is undoubtedly an error. National Income and Debt Charges OP Great Britain ■ National income, million dollars Debt charges, million dollars Debt Charges, Relative Figures Per Capital Per Cent of Income National income National debt charges At end of Napoleon- ic Wars (181 7)... At beginning of World War (1914) At end of World War (lOIO^ 1,944 u,ooo 11,000 119 1421 9. 10 2.S8 30.83 8.0 1.08 12.92 100 SIS 100 77 916 (b) The Prospect — Even the economists who advocated the capital levy or the war- wealth levy, because the burden of debt charges is so heavy im- mediately after the war, admitted that over a long period of years the new financial burden would be borne as easily as the relatively gigantic debt of the Napoleonic Wars was borne after a genera- tion following its close. The quotation from Macaulay of the wailing of the publicists about the unbearable debts of previous wars, may be recalled here. "On what principle is it that when we see nothing but improvement behind us we ought to expect nothing but deterioration before us? The prophets of evil were under a double illusion. They made no allowance for the eflect Digitized by Microsoft® 92 INTERNATIONAL FINANCE AND ITS REORGANIZATION produced by the incessant progress of every experimental science and by the incessant efforts of every man to get on in life. They saw the debt grow but they forgot that other things grow as well as the debt. They greatly overrated the pressure of the burden. They greatly underrated the strength by which the burden was to be borne." One of the factors that may make the burden of the debt greater is deflation, that is, an increase of commodities in terms of the monetary units. An increase of the production of goods faster than of gold or credit may make the burden heavier. But to the extent that business profits increase and are applied to the repayment of the debt, increased production will make the burden lighter. Furthermore, deflation means lower prices, and ultimately lower rates of interest. Therefore conversion or refund- ing of the debt may reduce the burden pari passu with the increase in the purchasing power of money, taxes and interest. The factors making the load lighter would be an increase in the gold output or of the use of credit instruments, or of the velocity of circulation. This is the gradual, continuous and historic process of inflation under the influence of which prices rise. Digitized by Microsoft® CHAPTER III FRENCH PUBLIC FINANCE * A Pre-War Situation The French public debt was handled with difficulty even in the eighteenth century. Except for Colbert and Turgot, who enforced a vigorous reduction of the debt and of debt charges, the French Ministers of Finance favored the policy of borrowing. The French Revolution was in large part due to the methods of financial administration.^ After the Franco-American War an ambitious program of public works added to the national debt. For a decade from 1881, the budget did not balance and loans were issued to meet the deficit. The extra-budgetary expenses in this decade exceeded fr. 5,000 million. From 1871 to 1918 the ' Official Sources: Annuaire statistique. Statistique generate de la France. Bulletin de la statistique generate de la France. (Quarterly.) Budget generate de la France. (Annual.) Expose de motifs du projet de toi (of the Revenue Laws). Bulletin de statistique et de legislation comparee. (Monthly.) Journal officiel : Senat debats et documents. Chambre des deputes debats et documents (Speeches of Ministers of Finance Ribot, 1915-16; Klotz, 1917-19, Frangois-Marsal, 1920, Doumer, 1931). Rapports generaux du commission de la budget, Senat et Chambre. The report of the Budget Committee of the Chamber (1919, 1918) contained beside the budget (i) an official history of French finances since August, 1914, (2) a study of the war finances of the other bel- ligerent, (3) war time history of the foreign exchanges on the various financial centers. Semi-official Sources: Buttetin de ta society d'economie politique. ' L'Economiste f rauQais, L'Economiste europeen. Revue de science et de legislation financieres. Revue politique et parlementaire. ' Gomel, Causes Financieres de la Revolution Frangaise. Stourm, Les Finances de L'Ancien Regime et de la Revolution. 93 ( Digitized by Microsoft® 94 INTERNATIONAL FINANCE AND ITS REORGANIZATION public debt increased from 13,000 to 31,000 million, and of an increase in revenue of fr. I,a86 million, 71 per cent was absorbed by increased charges on the debt. The existence of a large and diffused public debt was regarded as an advantage to the state. Owing to the lack of a surplus of revenue over expenditure, the government could not maintain an effective sinking fund. At several intermittent periods in the nineteenth century, a nominal sinking fund was inaugurated, but it produced little tangible result. The reductibn of debt charges was accomplished by con- versions of a large part of the debt from 5 per cent in 1883 to 3 per cent in 1902.^ French finances in 1914 were not in a condition to stand the strain of a war. The per capita debt in France was, by a wide margin, the largest in the world, twice that of Great Britain, five times that of Turkey, six times that of Russia, eight times that of Japan, ten times that of Germany, and fifteen times that of the United States. Debt per Capwa in igi4 France Belgium Austria Italy..' Great Britain Turkey Russia Japan. ...... Germany. . . . United States $166.20 94.28 84.99 82. SS 7S-03 31-35 27-95 21.74 17.18 "-33 For several years prior to 19 14 France had been wrestling with the problem of her peace-time budget. In the attempt to balance it, she had introduced an income tax and a tax on securities which was bitterly opposed by large investors and bankers and their press. Further, in order to meet current expenses, she found 'Hirst, F. W., The Credit of Nations. Report of National Monetary Commission, Washington : Government Printing Office, igta Bastable, C. F., Public Finance. Leroy Beaulieu, P. Trait£ de la Science des Finances. Le Trisor de la Rocque, Les Finances de la Ripublique. Say, lAoa, Les Finances de la France. Digitized by Microsoft® FRENCH PUBLIC FINANCE 9S It necessary to float a 3 J/^ per cent loan of 900 million francs to cover expenses in Morocco, and pay the cost of increasing her fleet and of carrying out the three-year military-service law. The basic cause of the poor fiscal condition of France was the policy of maintaining a large perpetual debt. The French debt increased forty-eight fold from 1800 to 1914. On the other hand the debt of Great Britain increased only two fold in the same period. No other country in the world showed an increase at all comparable with that of France. In fact the British debt at the beginning of the World War was only 678 million pounds sterling as compared with 861 millions at the end of the Napo- leonic Wars. Growth of Public Debt in France * (in million dollars) Date Debt 1800 138.7 181S 247.7 1848 i.iSo-9 1871 2,423 S 1912 6,336.2 July 31, 1914 6,6S2S Jan. I, 1919 28,702.6 July I, 1920 53,200. The burden of a large debt and the lack of a broad and expan- sible basis of taxation are the two factors which determined the manner in which France financed the war and which in large part explain the difficulty in which France finds herself after the war. B. Loans i. Cost of the Wat^ The cost of the war for six years from August i, 1914 was over fr. 233,000 million. The highest annual cost was reached in 1918, but it did not decline much in the two following years. About 20 per cent was raised from current non-loan revenue during 'Statesmen's Year Book, 1919; 1920 figures from M. Doumer's report for Finance Commission of the French Senate, Doc. Pari. S£nat, 1920, p. 344. •The best exposition of the war finances of France is contained in Jhe address of M. Klotz to the Chamber, December 29, 1919, Journal Officiel, Chambre, p. 5400, and in the advance report of M. Andre Lef ivre to Digitized by Microsoft® 96 INTERNATIONAL FINANCE AND ITS REORGANIZATION the six years, but up to the end of 1918, only 15.5 per cent was so raised. As a result of an increase in taxation after the war, this ratio rose. Advances by the Bank of France constituted an important source of funds, 13.7 per cent up to the end of 1919 and 1 1.7 per cent up to the middle of 1920. Loans constituted the chief reliance of the French Treasury during the war and furnished 68.8 per cent of the total receipts, up to the middle of 1920. The two loans issued during 1920 made it possible to fund a considerable part of the floating debt. According to M. Paul Doumer, the reporter of the Finance Committee of the Senate, the war expenditure of France from August I, 1914 to July 31, 1920 was fr. 233,300 million.* War ExPENDiTinRES or France Period Amount (in million francs) Per cent 1914 (5 months) igrs 1916 1917 1918 1919 J 1920 (7 months; Total 6,590 22,805 32.945 41,680 54,537 49,029 25.714 2.8 9.8 14. 1 17.8 234 21.0 II. 1 233,300 100. o Sources of Revenue Items Amount (in million francs) Per cent Taxes and monopolies 43.300 26,000 72,000 46,000 3S.OOO 19- S 11.7 32.4 20.7 157 Bank advances Treasury bills Total 222,300 the Chamber, Journal Officiel, December 26, 1919, pp. ij, 144, et seq. See Revue de Science et de Legislation Financiire, 1919, xvii: 4, 529-613; Les Finances de Guerre de la France. For a concise presentation see F. M. Williams, French War Finance. Federal Reserve Bulletin, February, 1921, pp. 174-181. •Journal Officiel, S4nat, July 19, 1920. For figures to the end of 1919, 8ee*address of M. Klotz, ibid. See also Rapport G6niral, Chambre, 1919; No. 6158, pp. 16-24, 37> 40- Digitized by Microsoft® t&ENCH PUBLIC FmANCE ^1 ii. Analysis of the Public Debt (a) Growth of the Debt Analyzed — Analysis of the growth of the debt of France indicates that increasing reliance was placed on foreign loans and that a large percentage of the annual increase in debt was of short-term character. In the following table the United States government advances, although they are demand obligations, are considered as long-term debts. Bank advances are grouped with short-term loans. Internal loans, long-term or short-term, even if held by foreigners, are considered as domestic loans. Classification ob Annual BoEROwrNGS by Percentages * Items igi4 191S 1916 1917 Domestic short-term 96.6 3-4 42.7 SS-3 S8.8 20.4 55.5 Domestic long-term 18.8 Total domestic 100. * 0.00 98.0 2.0 0.0 79.2 iS-i S-7 74.^ 9.6 Foreign long-term . .... 16.1 0.00 96.5 3-4 2.0 44-7 SS-3 20.8 73-9 26.1 25.7 Total short-term 6Si 34.9 •Foreign debt does not include about fr. 60,000,000 treasury bills sold in London and fr. 41,000,000 sold in New York, nor about fr. 300,000,000 of the first internal loan, subscribed abroad. (b) Analysis of the Total Debt— An analysis of the total debt up to January i, 1919, indicates that about 21 per cent of France's borrowings were external and about 79 per cent internal. On the other hand about 56 per cent of the debt was in long-term bonds and about 44 per cent was unfunded. If the pre-war debt is eliminated, the foreign debt and the floating debt will appear as a higher percentage of the war debt. The table follows: Digitized by Microsoft® gS INTERNATIONAL FINANCE AND ITS REORGANIZATION Analysis or the Fkench Public Debt as of January i, 1919 Items Billion francs Per cent of total debt Internal debt: Fixed 67.7 49.1 4S-9 Floating 33.3 Total domestic iS-i iS-S 116.8 79.3 External debt: Fixed 10.3 Floating 10.5 Total foreign debt 82.8 64.6 30.6 20.8 Fixed debt 156.2 Floating debt 43-8 Total debt 34-2 113-2 147-4 zoo.o Pre-war debt 23.2 76.8 Figures later in 1919 indicate a similar distribution and rela- tively greater long-term debt in 1920/ This analysis is significant. The large floating debt will con- tinue to be a disturbing factor until it is disposed of. Again, owing to the relatively large percentage of the external debt France will have an increased annual invisible debit in the balance of trade, and she will either have to export more to restore the balance of trade, or else suffer from the depreciation of her exchanges. Furthermore, should any reorganization of French finances take place, the large percentage of the foreign debt will make such a reorganization an international problem rather than an internal fiscal matter. 'M. Andr£ Lefivre, in a report to the Chamber of Deputies, Journal Officiel, Dec. 26, 1919, pp. 15, 146. For detailed analysis of debt as of March i, 1921, see Bulletin de Statistique et de Legislation Comparee, Feb., 1921, pp. 247-354. Report of Consul Chas. D. Westcott, Paris, in Commerce Reports, May 13, 1921, pp. 898-9, gives figures as of March t, 1921; total debt 302,743 million francs and foreign debt 83,245 million francs, taking 13.9 fr. to the dollar. Digitized by Microsoft® FRENCH PUBLIC FINANCE 99 iii. Advances from the Bank of France Of the three sources of funds open to a belligerent, taxes, loans and fiat money or fiat credit, the first two were closed to France in 19 14. Her tax system was not capable of expansion, the income tax had not yet been put into effect, and her richest revenue-producing provinces were invaded. Furthermore, she could not immediately resort to loans. Subscriptions on the 3j^ per cent twenty-five year bonds issued in July, 19 14, remained unpaid. Therefore, fiat credit was the sole remaining resource available. The declaration of a moratorium on August 11, 19 14, and the suspension of specie payment made it necessary for the state to rely upon the Bank of France for prompt assistance. Unlike the ways and means advances which were deposit credits on the books of the Bank of England, the advances to the state by the Bank of France were in the form of bank notes, for the people were unaccustomed to the use of checks. The French bank notes were legal tender, and gold payments were suspended. As the bank made advances to the state it had to raise the limit on the issue of bank notes, which in December, 191 1, had been fixed at fr. 6,800 million. On August 5, 1914, the limit was raised to fr. 12,000 million, to 15,000 million on May 11, 1915, to 18,000 million on March 15, 19 16, to 21,000 million on Febru- ary 15, 1917, to 27,000 million in February, 1918, and by succes- sive increases of about 3,000 million to 40,000 million in May, 1919, and 43,000 niillion in August, 1920.' The Bank of Algeria made advances to the state, but in relatively insignificant amounts. During 1914 Bank of France advances were the chief source of funds. Advances declined sharply in 1915. Subsequently they increased because of the lack of other easily tapped sources of funds. In 1914 Bank of France advances constituted 61.7 per cent of the total loans of the year and in 1915 only 5.8 per cent, _°Les Advances de la Banque de France a I'Etat. Economiste Fran- 5ais, May 24, 1919, pp. 543-5. _ ' _ The continuous increase in the limit of note issues of the Bank of France brings to mind the criticism of Andre Liesse of the suspension of the British Bank Act of 1844 during emergencies. See his volume on banking in France in the National Monetary Commission Report. Journal Officiel, April 29, 1920, July i8, 1919, Mar. 6 and a, 1919, etc. gives text of law. Digitized by Microsoft® 100 INTERNATIONAL FINANCE AND ITS REORGANIZATION in 1916 7.4 per cent, and in 1917 12.8 per cent. The increasing reliance on Bank of France advances is an indication of the weak fiscal policy of France. The extensive use of bank advances during 1919 was due to the desire of the government to avoid heavy taxation and thus to facilitate the transition from war to peace. In addition to making advances to the state, the Bank of France also discounted treasury notes, to the extent of fr. 3,755 million up to the end of 19 19, representing advances to allies. Bank of France advances were retired in part from time to time by the issues of long and short-term loans. The floating of every war loan was followed by a temporary decline in volume of advances to the state. To accelerate their retirement, the Bank of France was given the right to charge interest on the advances, as follows: On a permanent loan of fr. 200 million, no interest; on special advances up to fr. 21,000 million, 0.48 per cent; on advances of the next fr. 3,000 million, 0.35 J^ per cent; on advances above fr. 24,000 million, 3.0 per cent, of which 2j^ per cent is ' Advances to the State Year Million francs Per cent of total 1914 191S igi6 1917 1918 1919 Total. . 3,900 1,100 2,400 S.ioo 4,650 8,350 iS-3 4-3 9-4 20.0 18.2 32.8 25,500 100. credited to a fund to amortize the advances, and to guarantee bills extended under the moratorium." iv. Short-Term Loans In addition to advances from the Bank of France, the French government relied upon short-term loans because this type of security was popular in the money markets of Europe. Further- more, the decline in the volume of commercial paper as a result of the war made short-term government loans an acceptable sub- • Report of A. M. Thackara, Consul General at Paris. July 15, 192a Digitized by Microsoft® FRENCH PUBLIC FINANCE lOI stitute, particularly in view of the fact that the Bank of France rediscounts these bills or makes collateral loans against them. The theory underlying the use of the short-term bills was that it was a prompt and convenient way of getting funds which could be retired by subsequent long-term loans. The bons du tresor, treasury bills, ran from 6 months to one year, in denominations of lOO francs and upward. They were used before the war, about 434 million francs being outstanding on July 31, 19 1 4. These had been purchased largely by the banks, but during the war an effort was made to sell them direct to investors, particularly after the armistice. They were sold in foreign markets as well as at home. The amount outstanding at the end of each year follows: Year Million francs 1914 149 1915 1916 43 44 .1917 1918 30 S6S 1919* 205s •November 30. The bons de la defense nat'wnale, the special treasury bills issued during the war, ran from three to six months, but rarely over one year. They were also issued in denominations as low as five francs, in order to reach the small investor, and as a result they passed as currency. They were used in paying munitions makers. These bills carried several inducements to subscribers; the interest was payable in advance, they were exempt from taxation, they had a variety of maturities, they were convertible into long-term bonds and they were acceptable as collateral on loans at the Bank of France. Before the war the amount of bons outstanding was limited to fr. 940 million. This limit was raised on December 3, 1914, to fr. 1,400 million, and in June, 1915, to fr. 7,000 million. The volume rapidly increased and the outstanding bons de la defense nationale aggregated at the end of 1916, fr. 12,575 million; 1917, fr. 19,500 million; 1918, fr. 22,334 million; and 1919, fr. 46,140 million. The volume outstanding at the end of 191 9 was forty- nine times as great as the pre-war limit. The increase over the Digitized by Microsoft® 102 INTERNATIONAL FINANCE AND ITS REORGANIZATION previous year was 55 per cent in 1917, 14 per cent in 1918, and 106 per cent in 1919. The advances by the United States during 1918 made it possible to reduce these issues. The greatest increase both in amount and percentage occurred in 1919 — in ^^^t more than half of the total amount outstanding at the end of 1919 was issued during that year.^" A security, intermediate in maturity between the short-term bill and the long-term loan was the obligation de la defense nationale. Obligations resembled the exchequer bonds of Great Britain, and were issued for periods of ten years and later in the war for periods of six years. They bore 5 per cent interest, were issued at 96.5, and unlike the treasury bills were not limited in amount. As an inducement to subscribe, they were made tax exempt, and peculiarly the interest was paid in advance. These obligations originally brought little new money; they funded the short-term treasury bills and the remainder of the pre-war loan. At the end of 1919 fr. 568 million of the ten-year obligations were outstanding as compared with fr. 365 million at the end of 1918. In the effort to get funds, a new type of security was issued, the obligation-bons, a cross between short-term and intermediate- term loans. They were issued for five years, but were redeemable at the option of the holder at the end of any six months interest period and payable with a bonus of a half year's interest, if held to maturity. During the year 191 9 a new type of obligation de la defense nationale was issued. It was issued for six years, but was redeemable at the option of the holder at the end of one and one-half years, and at subsequent interest dates at increasing pre- miums. It bore 5 per cent interest payable semi-annually in advance. The inducements offered and the devices invented to obtain funds indicate a weak fiscal policy. V. Long-Term Loans The French fiscal policy was based on the assumption of a short war. Therefore, the short-term bill was the chief reliance of the French Treasury. It was only when the volume of short- term loans became unmanageable that long-term loans were issued, "Address of M. Klotz, Dec. 29, 1919. Journal Oificiel, Chambre, D6bats, p. 5400, et seg. Report of Consul General A. M. Thackara, July 15, 1920. Digitized by Microsoft® FEENCH PUBLIC FINANCE I03 and then they were chiefly funding loans and raised only a rela- tively small amount of new money. The Germans apparently were prepared for a long war and their periodic loans were timed with precision. The French loans were issued at irregular intervals. The first loan, the National Defense Loan, was issued in November, 1915, and although it was a rente perpetuelle, it was redeemable at the option of the government after January, 193 1. The rate was 5 per cent and the price 88. About 10 per cent of the total amount of subscriptions was received from abroad. About 50 per cent of the total subscriptions was in new money and the rest was in short-term bills and pre-war rentes which were con- vertible at 66, a figure somewhat above the market rate. This inducement may have been necessary in order to raise funds but the effect of it was to increase the. charges of the public debt because a 3 per cent rente convertible atj!66 was accepted in payment of a 5 per cent bond issued at 88. The interest on this loan was tax- exempt. The second loan was issued in September, 191 6, a rente per- petuelle, but also redeemable at the option of the government after January, 1931. The price was 88.75. Treasury bills, obligations, and the remainder of the 1914 3j4's were receivable in subscrip- tion. The interest rate was 5 per cent and the first installment was payable in advance. The loan was tax-exempt. The third war loan was issued in November, 1917. a rente perpetuelle, redeemable at the option of the government after January, 1943. The price was 68.60 and the interest rate 4 per cent. The yield was therefore higher than that of either of the earlier loans. As an inducement to subscribe, this loan was receiv- able in payment of the war-profits tax. Again bons, obligations, and the 3j4's of 1914 were accepted in subscription. As a result only about half the total subscriptions represented new money. The fourth war loan was issued in October, 1918, at 70.80 and bore 4 per cent interest. The yield was lower than that of the previous issues. It was a rente perpetuelle but callable at the option of the government after twenty-five years. The privilege of conversion, as in the case of the former loans, was extended to the bons and obligations as well as to the holders of coupons of Russian bonds maturing during 191 8, which were accepted up to 50 per cent of the total subscriptions. The interest on this loan was exempt from taxation. Digitized by Microsoft® I04 INTERNATIONAL FINANCE AND ITS REORGANIZATION The fifth or peace loan was issued in March, 1920, at par, the only loan issued at 100 since the beginning of the war. The rate of interest was 5 per cent. The novel feature of this loan was that the bonds were redeemable at a premium of 50 per cent, or at the rate of 150 francs for a loo-franc bond. Drawings are to be held semi-annually every September and March for sixty years after September, 1920.^^ The need for floating a lottery loan is a reflection on the strength of French finances, and was vigorously condemned as financial prestidigitation.^" The sixth war loan was issued in the fall of 1920 in denomina- tions from fr. 100 up.^* Like the fifth loan this also was issued at par and bore six per cent interest, free from taxation. The rentes were perpetual but the government had the option to redeem or convert the bonds after January i, 1931. Subscriptions were pay- able in treasury bills, in 3j^ per cent redeemable rentes, and in any of the previously issued war bonds, up to varying percentages of the subscription. The actual cash received was 33 per cent of the amount paid in. Long-term Wak Loans op France Number Date of issue Rate of interest per cent Price Amount Subscribed Million Francs Paid in cash Maturity Par value Paid in Million francs Per cent X 3 3 4 Nov., 191S Oct., 1916 Dec., 1917 Oct., 1918 Total.... Feb., 1920 Nov., 1920 Grand total 5 S 4 4 87.25 87. so 68.60 70.80 15.205 11,514 14,882 31.304 13,308 10,082 10,209 22,163 6,»8s S,42S 5.134 7,099 48 54 5° 33 Peijpetual} • 1 i 76.50 100.00 100.00 72,90s 16,150 27,000 55,752 16,150 27,000 23.943 6,300 9.100 43 39 33 igSot Feipetualt 85.40 "6,055 98,912 39.343 40 • Redeemable after 1943. t Payable by lot at 150. t Redeemable after 1931. The yield of the first loan was 5.73 per cent, of the second 5.71 per cent, of the third 5.83 per cent, and if redeemed at par by the government in 1943, the yield would be 6.52 per cent. The "Text of law in Econoraiste Fran^ais, Jan. 3, 1920, p. 9. "Liesse, Andr6, Des Emprunts a Lots, Economiste Frangais, Oct. 18, and Dec. 27, 1919, pp. 481-3, and 801-3. "Journal Officiel, August 3, 1920. Economiste Fran?ais, August 7, 1920, p. 171. Digitized by Microsoft® FRENCH PUBLIC FINANCE lOj approach of victory in the autumn of 191 8 made it possible to issue bonds at a lower yield, 5.65 per cent. The difficulties of the transi- tion period resulted in the issue of a lottery loan, which would yield from about 80 per cent down to 5.13 per cent, depending upon the date at which the bond is drawn for redemption at 150. The Ministry of Finance returned to sound financial methods in issuing the sixth loan at a yield of 6 per cent. During the period of hostilities the amount of cash was on an average 43 per cent of the amount paid in on subscriptions. In the transition period, the government relied on short-term financing and therefore the fifth and sixth loans were paid for not in cash but in other securities, to a larger extent than previously. The issue of bonds at a considerable discount will increase the burden of the French debt, should the option of redemption ever be exercised by the government. As Gide pointed out,^* a fixed debt of fr. 69,375 million produced only fr. 53,280 million in cash, and France must bear a burden of fr. 16,095 million in excess of the cash received. The average issue price of the bonds floated until the end of the war was about 76.6, and of all until the end of 1920 about 85.4. If the bonds are perpetual, and the discount is not amortized, this factor of course does not enter. vi. Foreign Borrowing (a) Long and Short-Term Loans — France resorted to short-term foreign borrowing early in the war. A loan for two millions sterling was issued through Roth- schilds. In the first year of the war, France sold about fr. 300 million of one-year treasury bills in London and about fr. 207 million in New York.^^ Again in 191 5 the English exchequer ad- vanced credits of about fr. 1,500 million secured by a deposit of gold of one-third the amount, and in 1916 the British treasury agreed to discount a limited amount of French treasury bills matur- ing three years after the war. The foreign subscriptions to the first internal loan amounted to about fr. 1,000 million. Short-term in- dustrial credits were opened in the United States through Bon- bright & Company for about fr. 75 million. The first and largest unsecured foreign loan was the Anglo- " Economic Journal, September, 1919. "Doc. Pari. Senats, 1915, p. 275- Digitized by Microsoft® I06 INTERNATIONAL FINANCE AND ITS REORGANIZATION French loan, dated October, 1915. The amount was $500 million, of which France received one-half. The price was 98, the rate of interest 5 per cent, and the term five years. The next step in her foreign borrowing was the mobilization of securities for the purpose of floating a secured loan. The pro- cedure followed was somewhat similar to that of Great Britain. The government called upon the holders of securities of neutral countries to deposit them for a period of one to three years, and agreed to add 25 per cent to the net return. Negotiable receipts were issued in exchange. The government reserved the right to hold or sell the securities, sales price being the highest quoted price during the preceding quarter.^® To render effective its control over the movement of securities in and out of the country, France prohibited the exportation of capital or securities for sale or deposit, or the opening of credits to foreigners or the purchase of shares outside of France. The first secured loan placed by France in the United States was for $100 million. The collateral was held by the American Foreign Securities Company. It was dated August I, 1916, ran for three years, bore 5 per cent interest, and sold to the public at 98. Another loan of $50 million was floated in September, 1916. The third secured loan floated in the United States amounted to $100 million, was dated April i, 1917, ran for two years, bore 5/4 per cent interest, and sold at 99. It was convertible at par into twenty-year, sj^ per cent bonds due April i, 1937. Loans Placed BY Fkance in the Untted States cp to April i, 191 7 Date Loan Par value (million dollars) October, 1915 July, 1916 September, 1916 October, 191 6 November, 1916 Anglo-French 250 loo SO SO 36 6S American Foreign Securities Co Secured loan. .* City of Paris Lyons, Bordeaux and Marseilles Industrial credits April, 1917 Total 6Si "Economiste Fran;ais, pp. 1254 and 26a, February 19, 1916, and p. 676, May 13, 1916, Journal Officiel, May 5, 1916. London Economist, June to, 1916. Commercial and Financial Chronicle, May 13, 1916. Digitized by Microsoft® FRENCH PtTBLIC FINANCE 107 The entrance of the United States into the war relieved France from her credit difficulties. The direct advances authorized by the United States up to June 15, 1920, totaled $3,048 million and the cash advanced as of the same date totaled $2,957 million. In addi- tion France obtained advances from Great Britain amounting to £470.5 million or about $2,290 million. French dollar treasury bills were issued through J. P. Morgan & Company, after August I, 1919. (b) Analysis of the Foreign Debt — A large percentage of the total debt is in external loans — at the end of 1919 about 20.8 per cent, excluding treasury bills and internal loans held by foreigners. Most of the foreign debt of France is held in the United States and Great Britain, with small amounts scattered in other countries. The United States holds 49 per cent. Great Britain 45 per cent, Spain 2 per cent, Argentina 2 per cent, Switzerland 0.5 per cent, and Japan 0.5 per cent. Analysis of the Foreign Debt of Fkance, January i, 1919 (in million francs) Items Fixed debt: United States Treasury advances Anglo-French loan, part Advances by banks in U. S City of Paris loan French cities loan Secured loan in U. S Japanese loan Total Floating debt: Treasury biUs deposited in English Treasury. . . Treasury bills deposited in the Bank of England Treasury bills sold in England Bank credit in Spain j ...... . Bank credit in Sweden '..^.'.,i. Bank credit in Norway '...'.'.. Bank credit in Argentina ■ Bank credit in Switzerland Total Grand total Amount Per cent 12,009.9 1.376.2 SSo-S 27s -3 201.6 S7S-0 147-5 79-4 91 3-6 1.8 1-3 3-8 i.o 15,127.0 100. II.83I.S 1,890.0 76.5 12.2 201.8 656.6 76.8 86.5 1-3 4.2 o.S 0.6 SSO-o 178.0 3.6 I.I 15,471 -a 30,598.2 Digitized by Microsoft® I08 INTERNATIONAL FINANCE AND ITS REORGANIZATION (c) Offset to Foreign Borrowing — Early in the war France made extensive loans to her allies. Up to the end of September 30, 1920, she had advanced in war materials to Russia fr. 4,210 million, to Belgium 2,286 million, to Roumania 758 million, to Serbia 706 million, and to Poland 431 million. The total advances made by France up to September 30, 1920, were fr. 13,617 million, which includes about 4,744 million of advances and about 8,873 million due for war materials given to them. Advances by France to Alues as or September 30, 1920 (in million francs) Country Cash advances War materials furnished Total advances Per cent of total 739 484 834 788 384 889 430 121 7S 4210 2286 707 431 7S8 376 100 S 4,949 2,770 I.S4I 1,219 1,142 «89 806 221 80 36.4 Belgium 20.3 II. \ Poland 9.0 8.4 Italy 6S 5.9 Czecho-Slovakia Others 1.6 0.6 Total 4744 8873 13.617 100. The foreign borrowing of France is more than offset if the pre-war foreign investments of France are included, amounting to about fr. 40,000 million, of which about one-fourth was in Russia.^'' Other sources indicate a higher proportion invested in Russia, from 18,000 million to 21,000 million francs, distributed as follows: With the Russian Imperial Treasury 7iOOO million francs In Russian public utilities, railroads, etc., more or less under government control... 9,000 million francs In industrial enterprises in private hands but with government guarantees 3,000 million francs However, as M. Andre Lefevre criticized M. Klotz on this score, only about fr. 13,000 million remain intact because the bulk " M, Klotz, in address to the French Senate, October ai, 1919. Digitized by Microsoft® FRENCH PUBLIC FINANCE 109 of French investments were in Russia, Turkey and Mexico. Yet, until January i, 1 92 1, the French treasury paid coupons on Russian bonds guaranteed by the Russian Imperial government. C. Taxes i. Principles and Policies (a) Analysis of Revenues — As shown above the ratio of war taxes to war expenditures of France amounted to about I per cent. The total taxes raised dur- ing the war did not greatly exceed the amount that had been raised in recent years of peace. The ratio of total taxes to total expendi- tures was 92 per cent in 19 13, about 16 per cent in 19 1 5, and about 15 per cent in 1916, 1917, and 1918. The relative total re- ceipts from all sources of taxation, using the 1913 figures as a base of 100, were 79 in 1915, 96 in 1916, 119 in 1917, and 127 in 1918.^* These figures indicate that France did not greatly increase her war-time revenues. The ratio of direct taxes to total taxes was about 29.1 per cent in 1913, 26 per cent in 1917, and 32 per cent in 19 1 8. Direct taxes in France produced only a small part of the revenue. The above percentages are taken from table on page 49. Revenues of France in million francs 1913 1914 191S 1916 1917 1918 Direct taxes Tax on war profits. Tax on intangibles. Stamps Indirect taxes Import duties Tax on sales Monopolies Miscellaneous Total. 634 138 1086 9°3 754 I03S S39 S089 496 153 117 745 577 931 290 437 "is8 612 714 764 844 270 893 683 520 1556 943 240 1017 193 242 89s 692 178s 1 108 254 3309 3799 5016 6186 727 714 252 "43 734 1314 210 1154 286 6534 "Allix, E., Les Nouveaux Impots, Revue Politique et Parlementaire, March 10, 1920, pp. 431-447. Digitized by Microsoft® no INTERNATIONAL FINANCE AND ITS REORGANIZATION Relative Figuees (1913 = 100) 100 100 78 78 69 69 141 141 160 191 114 Direct taxes including tax war-profit 227 100 6S 7S 99 121 128 (b) French and British Taxes Compared — The relatively light taxes levied in France stand out strikin^y in contrast to the taxes in Great Britain. A member of the Chamber of Deputies called attention to the fact that whereas from 1914 to 1918 French taxes rose only from fr. 90 to 103 per capita per annum during the w^ar, British taxes rose from 95 francs to 265 francs per capita per annum.^^ In 1919 the per capita tax in Great Britain was about 2.60 times as great as in France. The French taxes were not only less in amount than the British, but their distribution was quite different. The British relied chiefly on direct or personal taxes, the French chiefly on indirect or im- personal taxes. SotTRCES OF Taxation France Great Britain Ratio of British to Source Million francs Per cent of total MilUon francs Per cent of total French taxes in per cent Income tax 370 S8o 4S27 10.8 84.2 5,987 S,S°S 2,7S2 42.1 386 19-3 1620 870 Consumption taxes 61 Total S477 100. 14,244 lOO.O 260 The British total is 2.60 times as great as the French.'* But the British income tax yielded over 16 times as much as the French, the war profits tax almost 9 times, and the consumption taxes only 0.6 times the amount of the French taxes. The English levied relatively few taxes but relied on high rates to yield large returns. The French hesitated to draw upon the "Gide, Charles. French War Budgets. The Economic Journal, September, 1919. "Paris correspondence, London Economist, November 9, 1918, p. 6s4- Digitized by Microsoft® FRENCH PUBLIC FINANCE III few productive direct taxes, and resorted to numerous indirect taxes, bewildering in their variety and yielding relatively small amounts. (c) The Amount of War Taxes and Percentages of Total Cost — The total non-loan revenues of France were insufScient to pay interest on the war debt. Non-loan war revenues did not even equal the pre-war revenues. Revenues and Loans "' Expenditures, miUion francs Income, million francs August 1, 1914, to March 31, Advances to Allies 1919. 174,500 6,700 Loans Other revenues. 159,400 22,500 Foreign debt and other items 181,200 11,000 181,900 Total 192,200 Annual revenues before war S.000 24,000 Total equivalent peace revenues dur ing war period. . If monopoly and other non-tax revenue sources are excluded, total tax receipts during the war were approximately the same as normal tax receipts in pre-war years. According to Gottlieb the ratio of war taxes to war expenditures up to December 31, 191 8, was i.o per cent, and war taxes per capita per annum equivalent to 12 cents. The ratio of direct taxes to total taxes for the years 1913 to 1918 was as follows: Year Per cent 1913 191S 1916 1917 1918 29.1 27.9 24.2 26.2 3»-3 ''Peret, Raoul, President of Budget Committee; Journal Officiel Chambre, Debats, pp. 1058, et seq., March 7, 1919. Jeze, Gaston, Les Finances de la Guerre de la France, Revue Sci. Leg. Fin., xvii : 2268-298. Digitized by Microsoft® 112 INTERNATIONAL FINANCE AND ITS REORGANIZATION The ratio of direct taxes, including taxes on war profits, to total non-loan revenue was as follows: Year Per cent 1913 12.6 1914 iS-o 191S "S 1916 17.8 1917 ' 19.6 1918 22.0 (d) Diversity of Taxes — Through the year 191 5 the government hesitated to increase the rate of taxation or to find new sources of revenue. But as the debt charges grew an increase of taxation became imperative. In 191 7 the debt charges were fr. 7,645 million and the revenues only fr. 5,415 million. France lacked a working income tax and had to resort to many other types of taxes. These were chiefly indirect, such as a tax on retail sales, stamp taxes, taxes on legal documents, liquors, luxuries, and articles of consumption. Now the policy of financing the war largely through short-term loans and bank advances led to inflation, which caused acute suffering among the poor. Sales taxes and consumption taxes aggravated their difficulty. The use of a variety of indirect taxes has several disadvantages. They are not based on the principle of ability to pay. They are annoying and produce the impression that taxes are more burden- some than is really the case. The cost of collection of many taxes is relatively higher than the cost of collecting a few. The ultimate distribution of a limited number of taxes may be as just as that of a great variety. (e) Criticism of Tax Policy — The theory of French war finance at the outset was that the conflict would be brief and that increases in taxation should be postponed Until after the war. As the war continued the weak tax policy reacted unfavorably on the issue of loans. Because taxes were inadequate to meet the interest on loans, French credit de- clined even at home and the government had to offer special in- ducements to insure the success of the war loans. Furthermore Digitized by Microsoft® FRENCH PUBLIC FINANCE II3 the delay in introducing new taxation during the war made it impossible to recast the tax policy during the period of readjustment following the cessation of hostilities. As a result the state was unable to rely either on loans or on taxes and had to resort to borrowing at the Bank of France, which served to aggravate the difficulties of the period of readjustment. By that time the fiscal problem had become so serious that even heroic taxation afforded no solution of the problem of reducing the floating debt, and of retiring the excessive note issues of the Bank of France. The timidity in taxation prevented the building up of an effec- tive machinery of administration. Laxity and fraud in the making of returns was common. According to the British Ambassador at Paris "the impot cedulaire on wages brought in less than half the figure it ought to yield. The majority of workmen have torn up the notices sent to them and not one of them has been prosecuted. And again in the case of the general income tax, only 500,000 persons were assessed during the past year although in theory it is payable by everyone who earns more than fr. 3,000 a year and should obviously be paid by nearly everybody, since there is no workman or small tradesman in any town who does not make more than ten francs a day."^^ (f) An Apology for the Tax Policy — In criticising the French tax policy, several mitigating cir- cumstances should be borne in mind. The income tax had been introduced just before the beginning of the war, and it had not been possible to perfect the methods of administration. The declaration of a moratorium suspended the receipt of many incomes on which taxes might have otherwise been collected. The invasion of northern France affected the most productive area, which furnished over 15 per cent of the revenue. Again the proportion of mobilized men was 89.3 per cent of the total male population between the ages of twenty and forty-seven. The eight million men who were mobilized were entitled to postponed payment of any taxes to which they were subject. This privilege was granted also to the inhabitants of the invaded areas and of the area of military occupation and to landlords who could not collect rent on account of the moratorium. The tax collectors themselves were mobilized * British Board of Trade Journal, May 6, 1920, pp. 603 to 605. Digitized by Microsoft® 114 INTERNATIONAL FINANCE AND ITS REORGANIZATION SO that the tax administration became defective. The people left at home were women, children and the aged, whose income was much reduced and many of whom had to be supported on state allowances. Many of these were small investors whose income from Russian, Turkish, and other securities was completely cut off. Again wealth is distributed widely in France and the income tax would hardly reach the masses with small means, such as petty merchants, peasants, small landholders and clerks. And not least was the fact that France bore the brunt of the war and the govern- ment hesitated to impose heavy taxes for fear of breaking the morale of the people and of encouraging the defeatist element, which increased in power as the war dragged on.^^ ii. The Income Tax In spite of the opposition of the wealthy classes in France, an income tax law was passed under the budget for 1914, but the tax was not to go into effect until January i, 1915. Immediately after the enactment of the tax law the war broke out and although French revenues in 1914 and 1915 declined below the 1913 level, the collection of the income tax was deferred to January i, 19 16. The tax affected all persons with incomes of fr. 5,000 and over, but the full rate of two per cent applied only to incomes over fr. 25,000 There were abatements for dependent children and allowances for business losses. The tax administration was so ineffective that the making of returns was practically optional. It was estimated that about 500,000 persons would pay, but the actual results showed only 165,000 returns. About fr. 2,980 million of taxable income of 1914 paid about fr. 22,250 in taxes approximately 0.75 per cent. Criticism of the results must be tempered by the fact that the tax was an untried experiment which took place under war conditions. On July I, 191 6, the tax on income from securities was raised from 4 to 5 per cent and the tax on income from foreign securities was likewise increased. As a result of the experience with the first "Glde, Charles, French War Budgets. The Economic Journal, Sep- tember, 1919. Casenave, Maurice, Inflation and High Prices, Proceedings of the Academy of Political Science, June, 1920, p. 99. British Board of Trade Journal, May 6, 1920. Bloch, Jean, The Financial Effort of France During the War, The Annals of the American Academy of Political and Social Science, Ixxv, 164, January, 1918, p. 204. Digitized by Microsoft® FRENCH PUBLIC FINANCE "5 income-tax returns, the rates were raised and the administration was improved. The lower limjt of taxation was reduced from fr. 5,000 to fr. 3,000 and the rate was raised and graduated up to 10 per cent on incomes over fr. 150,000. Td secure the enforcement of the tax the failure to file returns was penalized. The returns were checked and penalties were provided for the failure to explain mooted points although the taxpayer could not be compelled to produce his books. As a result of the more effective administration of the tax, the comparative returns doubled in number and increased eightfold in yield. On July 31, 1917, the income-tax rate was raised from 10 to 12 per cent on incomes over fr. 150,000, with graduated rates on incomes up to that amount. In July, 1918, a more steeply gradu- ated set of rates was put into effect ranging from i^ per cent on incomes of fr. 5,000 to 16 per cent on incomes of fr. 150,000, and continuing upward to 20 per cent on incomes above fr. 550,000. The increased yield of the income tax was pointed out in a report to the Finance Committee of the Chamber of Deputies prepared by M. De Lasteyrie.^ Income-tax Retdsns Year of return Date of law Rate per cent Taxable Income Amount of Tax Average tax Million francs Relative figures Million francs Relative figures rate per cent 1916 1917 J918 1919 Dec. 29,191s Dec. 30, 1916 July 31,1917 June 29, 1918 2 10 I2-S 20 S047 70SS 8297 8i8s 100 140 164 162 45 230- 483 440 100 SOS 1060 968 0.9 3-3 S-8 S-4 The increase in the amount of the tax is an admirable proof of the capacity for increasing the yield of direct taxation. The Act of July 31, 1917, levied a head tax of 5 francs for every person having an income. A head tax or war impost was laid on every man of military age who was not mobilized. iii. Profits Taxes An excess-profits tax law was passed on July i, 1916, and ap- plied to profits earned during the war and for twelve months after "France's Financial Position. Board of Trade Journal, May 6, 1920, p. 603. Digitized by Microsoft® Il6 miERNATIONAL FINANCE AND ITS REORGANIZATION its close. The rate was 50 per cent upon the excess of profits over a pre-war normal which was based on the three years prior to August 1,1914. On September 30, 1916, the rate was increased to 60 per cent on the taxable excess above fr. 500,000. On July 31, 1917, an additional tax of 4>^ per cent on business profits exceed- ing fr, 5,000 was put into effect. There were various abatements on profits over fr. 1,500, the lower limit. At the same time a tax of 3j4 per cent applying to agricultural profits, to salaries, and to professional fees, was enacted. Because of the extensive evasion of the excess-profits taxes, a committee of the Senate and Chamber of Deputies investigated industrial profits and reported that it would be possible to collect over a half billion francs from the war industries,^' iv. Indirect and Other Taxes The indirect taxes yielded the largest part of the total tax revenue of France. The Act of July i, 1916, increased import duties, particularly on tropical products, tea, coffee, vanilla, pepper, cinnamon, cocoa, tobacco, sugar, molasses, etc. Luxury taxes were levied upon the use of horses, carriages, automobiles, clubs, ufwn hunting, billiards, and upon admission to theaters, cinemas, and other amusement resorts. Excise taxes were imposed on mineral waters and alcoholic drinks. Rates were increased on state monopolies, telephones, telegrams and postal service. The same act imposed a tax on retail sales amounting to 0.1 per cent on sales of one million francs per annum up to 0.5 per cent on sales of over 200 million francs. The sales tax was in- creased in 1918. In March, 1918, additional consumption taxes were put into effect, including a tax of 0.2 per cent on the retail price of all luxuries costing fr. 150 or more and in addition a tax of 10 per cent upon the retail price of any article designated as an article of luxury and upon expenditures made in so-called luxury establishments. The luxury taxes were subsequently modified as a result of much opposition.'" "November i, 1919, "Jcze, Gaston, Les Finances de Guerre de la France, Revue de Science et de Ligialation Financiires, 1919; xvii: 3, pp. 268-314, covers budget proposals, criticism and legislative debates. Digitized by Microsoft® FRENCH PUBLIC FINANCE II7 D. The Post- War Budget i. Sections of the Budget The French budget consists of three parts, the ordinary, the extraordinary, and the special section. The ordinary budget covers the normal and permanent expenditures of the government. This budget is met by taxation. The extraordinary budget provides for charges of a temporary nature, due to the liquidation of war-time obligations. It is temporary and ceases to exist after these obliga- tions are met. The extraordinary expenditures are covered by loans and by the liquidation of vi^ar stocks. The third section of the budget covers expenditures which under the treaty are recover- able from Germany, such as the reconstruction of the devastated areas of France, and pensions to the incapacitated, to widows and ' to orphans. These items are charged to an account of expenditures recoverable through payments to be received upon the execution of the Treaty of Peace. These are regarded as temporary burdens which France expects to transfer to Germany at the earliest possible date ; in the meantime France merely acts as a banker and advances credits to her nationals on account of the indemnity to be received from Germany.^^ ii. The Budget of igso The budget presented by M. Klotz on January 20, 1920, was modified by his successor, M. Marsal, and was adopted by both the Senate and the Chamber of Deputies on July 31, 1920. It called for an expenditure of fr. 47,932 million, which is 10. i times as great as the budget in 1913 of fr. 4,739 million. The public- debt charges in the 1920 ordinary budget are 2.5 times as great as the entire budget expenditures of 19 13. "M. Louis Klotz in the presentation of the budget, January ai, 1920. M. Francois Marsal in a letter to the Budget Commission, April 10, 1920. Board of Trade Journal, May 6. 1920, p. 603. Statement of the French High Commission in the United States. February 24, 1920. Economiste Fran^ais, January 31, April 17 and 24, igao, pp. 129-131, ♦81-484, 513-5x5. Digitized by Microsoft® Ilg INTERNATIONAL FINANCE AND ITS REORGANIZATION Budget Adopted July 31, 1920 Items In million francs Per cent of ordinary budget Per cent of total budget Ordinary budget: 11,633 7,629 2,370 129 535 3SO 10.9 0.6 24.3 £xDenses of ministries For collection of public revenues and operating public monopolies Total 21,761 S,42o 2o,7Si 100.00 45-4 Extraordinary budget 11.3 Expenses recoverable from Germany 43-3 47,932 100. SoDRCES or Oedinaey Revenue " Items Direct taxes and contributions. Indirect taxes Monopolies War profits tax Sales of war stores Sundries Total. Million francs 1,923 8,484 1,998 4,000 2,91s 2,45° 21,770 The extraordinary budget receipts are taken from loans made in 1920. The ordinary budget for 1920 is 4.6 times as great as the budget for 1913. The item, "service of public debt," in the 1920 budget is 9.0 times as great as in the 191 3 budget. The expense of ministries in the 1920 budget is 2.2 times that of the 1913 budget. The ordinary budget for 1921 was slightly larger than in 1920.°" "Source; Journal Officiel, August i, 1920, pp. 10,947-11,003. " Ibid. "L'Expoa* des motifs du Budget de 1921. Economiste Franfais, No- vimber 13, 20 and 2j, 1930, February 12, 1921. Digitized by Microsoft® FRENCH PUBLIC JPINANCE 119, Budget for 1921 (in million francs) Ejcpense Revenue Surplus Deficit Ordinarv biidset 22,327 S,499 16,5 7S 22,335 2,628 8- 2,871 i6,S7S Expenses recoverable from Germany. . . Total , 44,401 24,963 .... 19,438 The largest item In the 1921 hudget is the service of the public debt, amounting to fr. 10,244 million or 41 per cent of the total, and the next largest is the military expense of fr. 4,613 million or 21 per cent of the total, larger by fr. 1,097 million than in 1920. In addition the extraordinary budget shows a military expenditure of fr. 2,814 million or 51 per cent of the total of which more than half covers operation abroad in Syria, Cilicia, and Morocco. The deficit in the extraordinary budget is about equal to the military expenditures — a telling comment on the relations of finance and politics. For comparison the pre-war budget is given herewith: Budget op 1913 Items Branches of expenditure: Public debt. £:q)enses of the Ministries of War and Marine Other ministries Total , Sources of revenue: Direct taxes Indirect taxes Registration Customs Indirect contributions Taxes on bourse operations, on sugar, stamp taxes, etc Monopolies Tobacco Posts, telegraphs Sundries Total Million francs Per cent 1286 1450 27.1 30.6 42.3 778 625 678 S68 Sio 38s 4738 622 2649 969 499 131 SS-9 20.4 10.6 4739 too.o Digitized by Microsoft® 120 INTERNATIONAL FINANCE AND ITS REORGANIZATION iii. Tax Increases The tax law of June 25, 1920, provided for a substantial in- crease in taxation. The war profits tax of 50 per cent on the excess ove^pre-war profits was abandoned. A series of direct taxes, including special and general income taxes, provided for increased revenue. Business profits in excess of fr. 5,000 were taxed at the rate of 8 per cent, agricultural profits above fr. 4,000 were taxed at the rate of 6 per cent, and salaries and various forms of unearned income in excess of about 4,000 at the rate of 6 per cent. The income from real-estate was taxed at 10 per cent, subject to specified abatements. The income from mines was taxed at the rate of 20 per cent. The general income tax of 191 7 was levied on all incomes in excess of fr. 3,000 over and above allowances for dependents. The rates ranged from ij4 P^r cent of the taxable income between fr. 3,000 and fr. 8,000 up to iiJ4 P^r cent on the excess over fr. 150,000. The law of 1920 increased the exemption limit as well as the allowances for dependents. But the rates ranged froir. 2 per cent on portions of incomes between fr. 6,000 and fr. 20,000 up to 50 per cent of that part of the income exceeding fr. 550,000. An estate tax, applicable only if there were three children or less, ranged from J4 of 1 per cent to 3 per cent on estates of fr. 2,000 or less up to 7j^ to 39 per cent on the fraction exceeding fr. 500,000 depending on the number of children. In addition the heir must pay an inheritance tax ranging from i per cent to 59 per cent de- pending upon the amount of the inheritance and the degree of the relationship, subject to the limitation that the combined estate and inheritance taxes shall not exceed 80 per cent of the value of the property received by any heir. Of the indirect taxes the tax on sales is the most important, levied at the rate of i i/io per cent on the net sales of merchants and on the gross profits, commissions, interest and other charges of bankers and brokers. Several transactions were exempt such as dealings in bread, in products under a state monopoly, or in service under franchises, dealings by brokers whose charges are fixed by law, and dealers in commodities or services paying the luxury tax. In addition there were enacted a great number of indirect taxes, such as stamp taxes on legal papers, the transfer of securities or of Digitized by Microsoft® FRENCH PUBLIC FINANCE 121 personal property or real-estate. Excise taxes were levied on wines, liquors, beers, mineral waters, and playing cards. Consumption taxes were levied on tea, coffee, sugar, cocoa, and spices. The luxury taxes covered a long list of articles. There were taxes on automobiles, carriages and motor boats. Places of amusement such as music halls, moving picture houses, theaters were taxed on the gross receipts at rates ranging from 6 per cent to 25 per cent.'"^ France made earnest efforts to increase her revenues, and the tax statistics indicate progress in this direction. The returns for the first seven months of 1919 were fr. 975 million in excess of the estimates and fr. 2,000 million over the yield for the correspond- ing period for 1918. The amount of taxes collected in 1919 exceeded those of 191 8 by substantial percentages as follows: For the month of April, 25 per cent ; May, 22 per cent ; June, 20 per cent; July, 30 per cent; August, 19 per cent, and September, 32 per cent. The yield from indirect taxes and monopolies for June, 1920, was fr. 908 million, an amount 30.6 per cent in excess of the estimates and 29.6 per cent above the June, 1919, figures. The returns for the first six months of 1920 were fr. 1,635 million in excess of the estimates and almost fr. 2,000 million above the 19 19 figures for the corresponding period.^^ The increase of taxes in 1920 over 1919 per individual is an indication of France's effort to balance her budget. According to an estimate prepared by the French Minister of Finance, the total taxes paid on an income of fr. 260 thousand would amount in 191 9 to 25 per cent, and in 1920 to 42 per cent. By the same estimate an individual income of fr. 600 thousand would have paid in 19 19 28 per cent and in 1920, 61 per cent. A person wi^ an income of fr. 50 thousand, would in 1919 have paid 15 per cent and in 1920, 22 per cent. The corresponding taxes In the United States were considerably lower in both years. These estimates are not absolutely accurate for the rate per individual, but they serve to indicate France's effort to increase taxes. The increase in the national revenue in 1920 arose chiefly from indirect taxes. To meet the ordinary budget the following schedule of increased taxes has been put into effect as of July I, 1920: "Journal Officiel, June s6, 1920, pp. 8990-9005; also Economiste Frangais, July 3, 10, 17, 24, 31, 1920; pp. 7, 39, 71, 103, 137. Economiste Fran^ais. Le Rendement des Impots. Reported monthly. Digitized by Microsoft® 122 INTERNATIONAL FINANCE AND ITS REORGANIZATION Taxes Million fiancs Income taxes. .^... Tax on wealth. . ,. . . ^^ Sales tax 1,300 500 S.400 95° 3SO Better tax admmistration , . ii.Soo 20,000 The budget revenue, however, was not realized with respect to many of the taxes. For instance the sales tax which was to have yielded fr. 460 million per month produced only fr. 234 million or 51 per cent in September, 1920, fr, 203 million or 44 per cent in November, 1920, and fr. 152 million or 33 per cent in February, 1921. In a period of declining prices, revenues based on selling prices must decline. Except for the indirect taxes and monopolies the several items of the budget yielded less than the estimates, par- ticularly in the case of direct taxes. For the year 1920 the taxes collected amounted to 81 per cent of the estimates, and if the arrears be included to 91 per cent of the estimate. Estimated and Actual Revenue for 1920 Source Estimated revenue, MaUon francs Actual revenue. Million francs Per cent of actual to estimated revenue Direct taxes and contributions Indirect taxes and monopolies 1.923 10,482 4,000 2.91S 2,45° 7S7 12,060 2.393 1,650 727 39 60 56 Sundries ^0 Total 21,770 17,387 2,247 81 10 Grand total 21,770 19,834 91 Digitized by Microsoft® FRENCH PUBLIC FINANCE I23 E. Appraisal of French War Finance i. Facts The pertinent facts concerning French war finance, given in this chapter, stand out clearly. The percentage of total expenditures raised by taxation was very low. The needs of the war were met largely by loans and advances from the Bank of France. Loans were raised abroad to a considerable extent. Of the internal loans, a very large percentage were short-term or floating. The war was financed originally by means of advances from the Bank of France, followed by the issue of short-term domestic obligations, which were subsequently funded by long-term loans raising little new money. When the domestic credit supply proved inadequate, France raised some short-term loans abroad and later issued several external long-term loans, originally unsecured, and subsequently secured. The problem of financing the war became acute just before the United States entered the war. Government advances by the United States temporarily solved the fiscal prob- lems of France. For almost a year after the armistice advances by the United States continued. The internal financial policy of France after the armistice depended almost entirely upon the further issue of short-term funds and further Bank advances. ii. The Effects of French Financial Policy (a) Bank of France Advances — Because of the reluctance to raise money by extensive taxation during the war, France resorted to the policy of inflation. Notes issued by the Bank of France were not very different from fiat money printed by the government. The Bank of France not only advanced notes to the state, thus producing an inflation of the currency, but furthermore it discounted the ever-increasing volume of treasury bills and thus produced an inflation of credit. As a result the cost of living in France rose more rapidly than in either England or the United States, where a vigorous tax policy was followed. Consequently the value of the franc declined in those countries where the currency had not depreciated to the same ex- tent. The foreign exchange rates on France became increasingly unfavorable. In the policy of financing the war by inflation lay the cause of most of the post-war financial diflSculties of France. Digitized by Microsoft® 124 INTERNATIONAL FINANCE AND ITS REORGANIZATION (b) Short-Term Loans— In order to resort to extensive short-term financing, the legal limit on the issue of treasury bills was raised, again and again, whenever it was found convenient to obtain money through short- term obligations. As the volume outstanding grew, the Treasury found it increasingly difficult to raise funds and resorted to all sorts of devices such as the payment of interest in advance, the extension of the privilege of redemption at the option of the holder at the end of any interest period, and the payment of a bonus of a half year's interest if the investor did not exercise the option before maturity. As the ratio of unfunded debt to the total debt in- creased, the government found the maturing short-term debt un- manageable and renewals had to be made at ever-increasing rates of interest. During the last year of the war a long-term loan could hardly be raised, and treasury bills. Bank of France advances, con- stituted the chief reliance during 191 8. The French followed a hand-to-mouth policy. Opportunism rather than foresight was its guiding principle. (c) Long-Term Loans — The failure to develop vigorous measures of taxation reacted to the injury of the loan policy. Probably the most serious mis- take, from the point of view of after-war taxation and the balancing of the budget, was the exemption from taxation of income from war loans. It is not quite correct to say that the French internal debt constitutes no burden because "what the government takes out of the pockets of the French holders in taxes to pay the interest on its bonds, it returns to their pockets in the interest that it pays them. Figures for the income of the people and figures for the budget of the state are thus swollen by what is after all merely a transfer of funds."'' Quite the contrary is true. The burden of interest payable by the state is increased, because the state has forfeited the right to tax the income on war loans, or because of a weak tax policy has had to bargain it away. Another indication of the effect on long-term loans of the opportunist fiscal policy was the increasing discount on bonds issued. According to Gide, the average price at which French bonds were floated was about 76, or 24 points below par. If the bonds are _ " Anderson, B. M. Effects of the War on Money, Credit and Bankine in France, p. 103. Digitized by Microsoft® FRENCH PUBLIC FINANCE 125 perpetual, the only effect of the discount is to make the return higher than the rate of interest. But if, as is likely, the state will exercise the option of redemption after 1931 or 1943, it will have to pay about fr. 20,000 million in excess of the monies received by it, making the yield of the loans considerably higher. The long-term loans raised new money only in part. They made possible funding operations and the decrease of the floating debt and to some extent the temporary reduction in the aggregate Bank of France advances. In the later loans, subscriptions were accepted in the form of loans already outstanding and bearing a lower rate of interest. Thus, interest charges were increased, but no fresh funds were raised. Again, after the situation in Russia became chaotic, France accepted matured Russian interest coupons in payment of subscriptions to her own long-term loans. The right of conversion of loans into later issues was maintained prac- tically throughout the war, thus raising the rate of interest. This was not true either in England or the United States. Because French credit was not supported by a consistent policy of taxation, the government had to offer all sorts of inducements to secure subscriptions. Long-term securities were receivable for excess- profits taxes, which were intended to meet current expenses. To make ten-year loans acceptable, they were sugar-coated with features of short-term loans giving the holder an option to redeem at any interest date, and the interest on them was paid in advance. To induce buyers to hold the bonds, premiums were offered on redemp- tion on a scale increasing annually to maturity. The percentage of foreign debt increased as the war continued. In the mobilization of her securities for the purpose of obtaining further loans abroad, the French Treasury had to offer more favorable terms than the British did. To cap the climax, French credit had so deteriorated by the end of the war that the Credit National found it necessary to resort to a lottery loan in spite, of the government guarantee of interest and principal. Under its provisions a fifty franc bond might have the chance weekly of drawing fr. 1,250,000 as a prize. The premium bonds were traded in on the London Stock Exchange shortly after issue but dealings in them were declared illegal under the anti-gambling act of Parliament of 1823. In the loan issued November, 1920, interest-bearing certificates for small aniounts were issued in cur- rency size to circulate as money and bear interest at the same time. Digitized by Microsoft® 126 INTERNATIONAL FINANCE AND ITS EEOEGANIZATION The unhappy experience of the United States in the American Revolution and the Civil War seemed to have failed as a deterrent. (d) Taxes — The chief defect of the tax policy during the war was the lack of a broad basis of taxation and the need for resorting to a multi- tude of diverse taxes each yielding relatively little. During the war France raised a smaller percentage of her war expenditures by war taxes than any of the other major belligerents. France relied chiefly upon indirect taxes. Because of the lack of an effective and well administered income tax the treasury was hard pressed to find new and productive sources of revenue. On the whole the tax policy was weak, one-sided and unproductive. The inflation of currency and credit caused a rise in prices, which in effect con- stituted a reduction in purchasing power or a steep and ungraduated income tax on all, poor or rich. This grave injustice was aggra- vated by the levying of consumption taxes which further increased the cost of living. This increase was in proportion to the size of the family and defeated the measures to increase the population. The sales tax, the mainstay of post-war fiscal policy, is unreliable because its yield declines as prices fall after the war. The tax policy of France was economically unsound and politically un- democratic. (e) Change of Fiscal Policy — Like the United States in the War of i8i2, France had to change her policy in the middle of the war. The original policy, if there were any such, had broken down. France had expected to finance the war by loans and Bank of France advances and to resort to taxation after the war. She reversed this policy and undertook to introduce extensive tax measures from 1916 onward. The long continuation of the war had exploded the original theory of finance adapted to a short war. iii. The Causes of the Difficulty (a) Bad Pre-War Situation — France did not choose a policy of war finance, it was thrust upon her by the consequences of her pre-war policy. The French theory of a perpetual debt, as a. source of investment for the savings Digitized by Microsoft® FEENCH PUBLIC FINANCE 12? of her population, has proved a danger and a stumbling block in national finances. For forty years before the war, administration after administration lacked the courage to deal with the debt, left as a legacy of the Franco-Prussian War. The pre-war fiscal situa- tion in France was not sound. To balance the budget a loan was floated. To meet current expenses for the army and navy, it was necessary to issue a loan of about fr. goo,ooo,000. The war broke out while the installments on this loan were being paid. France's tax system before the war was inequitable. There was relatively little direct taxation as in Great Britain. There was less taxation graduated in accordance with ability to pay. The application of the principle of ability to pay is not only sound ethically and politically, but it is practical economically for when taxes must be promptly increased, a rise in the rates applicable to the wealthy classes in the simplest, surest, and quickest way of increasing government revenues. The system of taxation in France before the war was inexpansible. When the income tax law was finally passed, in spite of the opposition of the wealthy classes, there was little opportunity to perfect the details of administration before the war broke out and exposed the defects in the pre-war scheme of taxation. (b) The Theory of a Short War — The theory of French finance was that the war would last a short while, and that therefore short-term loans and advances from the Bank of France would afford adequate temporary financing. Permanent fiscal measures were to be enacted after the war. France's fiscal policy probably would have worked in a short war, but certainly no better than the British or the American program did. However, continuation of the war broke the scheme. French finances were saved by American intervention. The justification of the French program by Charles Gide, Maurice Casenave and J. Frederic Bloch must be followed sympathetically by a world that has seen France bleed and suffer grievously. But why should not the faulty financing during the French revolution and the make- shift financing in the United States of the American Revolution and of the War of i8i2 have furnished adequate historic examples of a policy not to be followed ? As a consequence of the short-war theory of finance, the govern- ment found it necessary to meet the burdens of the transition period Digitized by Microsoft® 128 INTERNATIONAL FINANCE AND ITS REORGANIZATION without resort to additional taxes or to long-term loans. Financ- ing during the year after the war was effected by a large increase in the floating debt and an increase in the issue of bank notes, — two factors resulting in a rapid rise in prices. On the theory that the Government was to give industry and commerce an opportunity to resume its pre-war status, without the obstacles of increased taxes or of a big funded loan, the credit pyramid was rendered more unstable. The fallacy of the policy became apparent at the end of the year and the country insisted upon the application of sound fiscal principles. iv. The Remedy A history of what France did financially during the war makes the remedy obvious — a reversal of the war policies is the logical course. The country must retrace its steps. It must reduce the bank advances, it must fund the floating debt, it must make provi- sions for sinking the war loans. How may this be done? On the assumption that the condition is not beyond remedy, there must be further progress along the sound and sane lines which were adopted in the middle of the war, — an increase of direct taxes based on the principle of ability to pay. The war profiteers must be made to pay to the limit the expenses of the war. Perhaps some legal method might be devised to restore to the state the right to tax incomes on internal loans which it so thoughtlessly forfeited during the war. Then, only, will payment on the internal debt become a bookkeeping transfer of funds. France, crushed but not brokeni has made remarkable progress toward industrial recovery and fiscal reform. Applied to her fiscal problems, the courage and the re- sourcefulness she displayed during the war will surely solve her financial problems in the future. V. The Outlook (a) The Indemnity — ' The estimate of war damages varied considerably. Deputy Louis Dubois reported that the damage done to the invaded depart- ments amounted to fr. 119,000 million, the damage to agriculture fr. 37,000 million and military expenses, pensions, etc., fr. 44,000 million or a grand total of fr. 200,000 million." "In Economiste Francaia, March 8, 1919, p. 301, a low estimate is made of fr. ii9,Soi million. Digitized by Microsoft® FRENCH PUBLIC FINANCE 120 On the other hand Rene Pupin, a noted economist, estimated the property loss in the invaded regions at about 15,000 million to 20,000 million francs, and J. M. Keynes, representing the British Treasury at the Peace Conference, independently estimated the damage at about fr. 12,500 million.'^ Mr. Pupin also adds the loss of foreign investments, losses of rolling stock, ships and live- stock, and the loss of the annual savings and arrives at a grand total loss of 77,000 million to 87,000 million francs. The estimate of the French section of the Reparation Commission for war damages in France was fr. 62,043 million. In contrast with these figures is the German estimate of the indemnity due to France of approximately mk. 7,228 million, submitted in a statement by Ex- President Poincaire, head of the French section of the Reparation Commission.^" The amount of the indemnity was fixed at mk. 132,000 million, of which France was to get 52 per cent. The immediate financial outlook in France depends upon the amount realized on the indemnity. The terms of the Treaty of Peace, if they could be carried out, would assure a bright future and a speedy recuperation of France. Under the financial clauses of the treaty France was to obtain before May i, 1 921, in addition to the railway materials, agricultural appliances, and other property conveyed as restitution, a part of the mk. 20,000 million in gold demanded of Germany, a portion of an issue of gold bonds of mk. 40,000 million bearing 2 per cent interest, a part of the German ship tonnage and of the German stocks of dyes, a part of the 7,000,000 tons of coal to be conveyed annually for a period of ten years, the repayment of the cost of the army of occupation, a pre portion of the German interests in Russia, the right to sequester all German property in Morocco, and a mandate over a part of the German colonies. Alsace-Lorraine was returned to France free of all debt. After May 1, 1921, France was to have the right to claim full reparation for all damage done to property in France during the war, and the payment of the cost of all pensions and soldiers' allowances. On the other hand, Germany was to make formal acknowledgment of the reparation debt to the Allies, was to forfeit the right to dispose of her gold, and was to denounce all treaties "Keynes, J. M, Economic Consequences of the Peace, pp. 124, 1*7, Rene Pupin, Kconomiste Frangais, October 19, 1918. "Le Matin, August 2, igao. Digitized by Microsoft® 130 INTERNATIONAL TINANCE AND ITS REORGANIZATION concluded by her prior to 19 14 and to enact legislation to facilitate the execution of the treaty."' The future of France depends upon the extent to which the Allies help her rebuild the devastated areas. This is a just and undeniable claim. Many Frenchmen believe that "German obliga- tions to France must be made negotiable by the Allies before Germany actually pays, else all the taxation of Frenchmen to the limit and the issue of French loans to the limit will not put France on her financial feet again." Two unsuccessful bids for inter- Allied cooperation were put forward at the Hythe Conference. On May 16, 1920, the suggestion was made that the French debt to the United States be transferred to Germany partly by the issuance of German bonds to the United States. This tentative plan was abandoned owing to the lack of consent of the United States. A proposal of a loan based on the German debts and underwritten by the United States and Great Britain also failed of acceptance. In spite of the obvious difficulty Germany is having in solving her own financial problems and of her present inability to pay any substantial indemnity to France, the French still count on large German indemnity payments. Almost half of the 1920 budget, fr. 22,000 million, consists of "expenses recoverable under the Treaty of Peace." If Germany does not pay, the recuperation of France will be a very slow process. (b) The Future Budget — The so-called ordinary budget for the year 1920 calls for revenues of about fr. 22,000 million, the extraordinary budget for fr. 5,000 million, and the special budget for the rebuilding of the devastated areas, etc., for about fr. 20,000 million. The revenue for 1920 failed to meet the ordinary budget, that is the normal and permanent expenditures. Charles Gide, in the Economic Journal for September, 1919, estimated that the future normal budget would be fr. 22,000 million, exclusive of the sinking-fund requirements. The extent to which this charge would increase the budget depends upon the rate of conversion of the loans and upon the amortization of the debt of over fr. 200,000 million. There may be some reduction in the ordinary budget as time goes on, for "Finance Minister Klotz in the Chamber of Deputies, in debate on the ratification of the Treaty of Peace, September 15, 1919. Digitized by Microsoft® FRENCH PUBLIC FINANCE 13I the Ministry of Finance appointed a Committee of Inquiry, the aim of which is to help reduce public expenditures, within the limits of available revenues, if possible.^* Again as deflation sets in, the state can dispense with subsidies to lower the cost of living. In the three years 1917-1919 the wheat subsidy amounted to fr. 4,500 million and in 1920, owing to the fall in the value of the franc, the bread subsidy amounted to fr. 3000 million. As a result of increases in taxation France probably will be able to find sufficient revenue to meet the so-called ordinary budget in the future. In the words of the chairman of the French Budget Commis- sion, "if the Allies did not leave France to bear the expenditure chargeable to Germany, France would experience no serious finan- cial difficulties in years to come, provided that the ordinary budget was immediately adjusted by means of taxation and econornics."'^ According to Senator Andre Cheron, "it is a question of life and death for France. If Germany does not pay the problem is Insoluble." *"" Ex-President Poincare said equally bluntly, "if France does not obtain Hnancial reparations next year, she runs the risk of bankruptcy." (c) The French Diagnosis — The French have not hesitated to face their financial situation. M. Peret, chairman of the Budget Commission of the Chamber of Deputies, stated this situation candidly, " "Where are. we going to get the money? All we know is the total of the bill. The Allies will aid us when they are convinced that we are determined to demand sacrifices of the French people. The success of our financial arrangements with England and America depends upon the reshaping of our internal finances." The Minister of Finance, M. Frangois Marsal, in an address to the Chamber said; "Despite our efforts, there is a feeling of distrust abroad about our power to restore the national finances. This mistrust is responsible for the high rate of exchange. Nations which never doubted our ability to win the war are now doubting whether we shall win the economic struggle which began at the "A decree of March 14, 1930. "Journal Officiel, Chambre, April 10, 1920. "Journal Officiel, Senat, March 17, 1921. "See also Allix, Edgard, De I'urgence d'un programme financier et economique. Revue Politique et Parlementaire, Feb. 10, 1920, pp. 291 et seq. Digitized by Microsoft® 132 INTERNATIONAL FINANCE AND ITS REOEGANIZAION signing of peace. Foreign treasuries are closed to us and we can not consider the possibility of raising an important loan abroad. M. Paul *Doumer, in a report to the Senate in behalf of the Commission on the Budget, May 1 8, 1920, called attention to the fact that the government had done nothing to improve the critical financial situation. "It has lived, ever since the termination of the war, on the glory of France. The world has entire faith in France but is losing confidence in her administration." *^ (d) The American View — With sentiments of generosity toward a brave and suffering people, many American observers stressed the psychological traits of the French as a sure factor making for the restoration of her pre-war economic prestige.** In the words of an authoritative writer on financial problems, "How will France emerge from the terrific economic strain of the present war? On that question we have some historical precedent to guide us. France, three times in the past two centuries, has been completely defeated and left in a state of seeming economic exhaustion — at the end of the long campaign of Louis XIV, the final overthrow of Napoleon, and at the crushing climax of the Franco-Prussian conflict. After each of these experiences, the world witnessed the extraordinary spectacle of France promptly resuming her place in the economic system, and in the end displaying a tangible economic power even greater than before. It is impossible that this should have occurred writh- out the possession of the national qualities of which her enemies have failed to take account. If so, it is difficult to imagine the France of the longer economic future occupying in the economic system any different position than she has occupied in the past." *^ The friends of France do her an ill turn in veiling the truth. The defeat of France in the Napoleonic Wars marked the final surrender of world supremacy to England, after a struggle lasting half a century. After the Franco-Prussian War, France yielded "Economiste Franfais, January 29, igao. "See also Raffa1ovich,_ Arthur, Des dettes d'Etat et de leur liquidation, Les Discussions dc la Society d'Economie Politique de Paris, Jan. 5, 1920. "Laughlin, J. Laurence, Credit of the Nations, New York: Scribners, 1918, pp. 193, 196. " Noyes, A. D., Financial Chapters of the War, New York : Scribners, 1916, pp. 205-6. It should be noted that this was written early in the war before the debt grew so large. Digitized by Microsoft® FRENCH PUBLIC FINANCE I33 second place to rapidly growing Germany. The outcome of the World War is in doubt. France and Germany as well, face the relentless natural law that wars, frequent or long protracted, debilitate a nation. History is strewn with the wrecks of exhausted military powers. With a supreme national effort, France will undoubtedly revive. She needs, primarily, peace, prolonged peace. Further she must increase her population, and not rely on foreign alliances, or on militarizing her African colonials to redress the imbalance of population in Europe. She must invest her savings, not in second- rate governments but in developing domestic industries, and stimu- late essential rather than luxury production. As her publicists, Victor Boret, Edouard Herriot and Henri Hauser have pointed out, France must apply the principles that changed Grermany from an inferior power in 1870 to a dominant factor in world politics in 1914. Many of the optimistic forecasts failed to take into account that a large part of the French debt is held abroad, that a large part of the remainder is a floating debt, and that the income of internal war loans is exempt from taxation. And even if the income from war loans were taxable, the redistribution of taxes in the form of interest is always a difliicult and sometimes a wasteful economic process. Furthermore as the enormous note issues of the Bank of France are retired and deflation sets in, the burden of the debt, that is the cost in goods, will increase unless the debt is converted and the interest reduced. Some Frenchmen pointed to the remarkable expansion of the United States after the Civil War.*' However, they overlook the fact that the South, lacking financial help, had barely overcome the effects of the war after a generation, and that the North thrived only because of the opening of the agricultural west to the great migrations of European peoples. Without financial help, France like our South will recuperate slowly and even then her recovery will be conditional on an increase of population. The colonial empire of France, with its black inhabitants, has not the inherent potentialities of development of our western states, which became peopled with vigorous white stock. However, the record of France in the year after the war is "Casenave, Maurice, The French Situation, Proceedings of the Academy of Political Science, iv, i : 104, June, 1920. Digitized by Microsoft® 134 INTERNATIONAL FINANCE AND ITS REORGANIZATION an earnest of her future recovery. The rapid increase of tax revenues, the speedy restoration, under great difficulty and without well-deserved assistance, of her agriculture and industry, the amortization of over fr. 2,000 million since the armistice, indicate the possibilities for improvement, if the French but will it. Under a vigorous ministry, the financial situation may be improved by a heroic liquidation of the inflated currency, by a funding of the floating indebtedness, and by the adoption of a scheme of direct taxation which will be imposed in accordance with the ability to pay and therefore in proportion to the productivity of the source. Perhaps the realization of the futility of the hope of obtaining the expected huge indemnity from crushed and impoverished Germany will be the first step toward developing that self-reliant financial policy in France which is the basis of all credit and is essential to the salvation of any nation. A very sober prognosis was given by a noted French economist at the conclusion of a study of French war finance. "The financial and economic future of France is gloomy. But the vigor of the French people is great, as their history shows; iind their spirit of economy and thrift is traditional. In spite of the enormous diffi- culties which seem to stand in the way of her recoverj', the French nation will come out of the terrible trials she has experienced, triumphant. That triumph, no doubt will be a matter of many long years."*' "Jize, Gaston, The Economic and Financial Position of France in igao. Quarterly Journal of Economics, XXXV: i, February, 1921, p. 210. Digitized by Microsoft® CHAPTER IV GERMAN PUBLIC FINANCE ^ A. Cost of the War and Public Debt i. National Wealth and National Debt Before the War In view of the fact that the debt of Germany after the war constitutes over 60 per cent of the money estimates of national wealth of Germany before the war, the pre-war estimates are of interest. In 191 1 HelfEerich, the former Minister of Finance, and Ballod, a noted statistician, independently set the amount at about mk. 360,000 million.^ J, C. Stamp, the English statistician, accepts Helferrich's figure. At the outbreak of the war, Germany had the lowest debt of any of the major belligerents then engaged, approximately $17.00 per capita. The figure for the United States in 1917 was $11.33 per capita. "Bibliography: Official— Vieiteljahrshefte zur Statistik des Deutschen Reichs. Statistisches Jahrbuch fiir das Deutsche Reich. Deutscher Reichs-Anzeiger und koniglich preussicher Staats-Anzeiger. Reichshaushalts-Etat. (Annual). Budget details. Stenographische Berichte fiber die Verhandlungen des Reichstags, addresses of Ministers of Finance Kuhn 1914-15, Helfferich 1915-16, Von Roedern 1916-18, Schiffer 1918-19, Erzberger 1919-20, Wirth 1920. Reichs-Gesetzblatt, a chronological and indexed record of legislation. Semi-official — Finanz-Archiv. Volkswirtschaftliche Chronik. Frankfurter Zeitung. Schmoller's Jahrbuch fiir Gesetzgebung, Verwaltung und Volkswirt- schaft im Deutschen Reiche. Die Bank. Berliner Boersen Courier. Deutscher Okonomist. 'Helfierich, Karl, Deutschlands Volkswohlstand, 18S8-1913. Berlin: G. Stilke, 1913. 13s Digitized by Microsoft® 136 INTERNATIONAL FINANCE AND ITS REORGANIZATION The low per capita debt of Germany, compared to the other powers, was due to the comparatively recent birth of the Empire. However the increase in the debt was not insignificant in the generation before the war. After 1886, when certain expenses could no longer be met out of current revenue, they were separately stated, as an extraordinary budget, and were covered by borrowing. The subsequent growth of the imperial funded debt was rapid. But as productive assets were acquired by the state, the debt was less of a burden than it would seem. In fact, profits on government owned railroads were sufficient before the war to pay the interest and sinking fund charges on the entire imperial debt. Imperial Funded Debt ' Year Total, million marks Per capita, marks 1877 1881 1891 1901 1908 1913 72.2 267.8 1317-8 2395-7 4003. S 4802 . 2 1.66 S-90 26.56 42.29 63.78 70-75 Owing to the federal form of organization and to the inadequacy of imperial revenues, the states contributed out of their revenue to the budget of the empire from 1872 to 1878 and again after 1899. The debts of the states and municipalities of Germany also grew rapidly before the war. Imperial State and Municipal Debts (in million marks) Year Empire States Municipalities Total 1881 1908 1913 268 4003 4802 5,244 14,362 17,700 772 5,296 11,900 6,284 23,661 34,402 " Hirst, F. W. and Bastable, C. F., ibid. Wurm, E., Die FinanzgeschicUte des deiitschen Reichs, 1910, Digitized by Microsoft® GERMAN PTTBLIC FINANCE 137 ii. The War Debt of the States and Cities The constitutional division of powers between the Empire and the federal states denied the Imperial Government the right to levy an income tax, and many expenditures for national purposes were borne by the federal states and cities, such as the cost of social service during the war. Up to the end of 1916 eight Saxon cities had' incurred a war debt of about mk. 250 million, and the war expenses of the cities of Saxony having more than five thousand population amounted to about mk. 400. Leipzig alone had spent over mk. 100 million for war relief up to the first of October, 1917. As a result of the increase of the local debts, state and city taxes were heavily increased, and in some cases it was necessary to raise the tax limit in order to meet debt charges. Even during the war, the cities had been urging the assumption of their debts by the Empire and in view of the fact that the new constitution grants the Empire the right to levy an income tax, in competition with the federal states and cities, the pressure for the assumption of local debts by the Empire is increasing. Discussion of the debt of Germany should therefore take into account the debts of the municipalities and of the federal states as well as of the Empire.* iii. The Growth of the Debt The expenditures of each year increased as a result of the larger scale of operations and of the depreciation of the currency. The expenditures during the war were given by Dr. Schiffer, Minister of Finance, in an address to the German National Assembly at' Weimar, February 15, 1919: Year Million nia.rks 1914 191S 1916 1917 1918 Total.... 7,500 23,000 26,600 39>5oo 48,500 I4S.IOO *Leip2iger Neueste Nachrichten, January 15, 1918. Also Laughlin, ibid., pp. 263-4. Digitized by Microsoft® 138 INTERNATIONAL FINANCE AND ITS REORGANIZATION In addition mk. 6,000 million of treasury bonds were issued and mk. 9,500 million of credits were extended to the allies of Germany, making a total of mk. 160,600 million up to the end of 191 8. The rate of increase may be seen from a table of average monthly war expenditures given in marks as well relatively: Average Monthly Was Expenditubes Period Million marks Relative figures Aug. 1, 1914-June 30, 191S July I, igis-June 30, 1916 July X, 1916-June 30, 1917 July I, 1917-June 30, 1918 July I, 1918-Dec. 31, 1918 167s 2008 2867 3908 4358 100 120 171 233 260 By the autumn of 191 8 mk. 139,000 million were voted in twelve war credits, as follows (the revolution in November, 191 8, prevented the passing of the vote of credit of mk. 15,000 million, proposed in October) : War Credits Voted August, 1914, to November, 1918 No. Date of vote Million marks I Aug. 1,1914 S,ooo 2 Dec. 3. 1914 S,ooo 3 Mar. 22, 1915 10,000 4 Aug. 31, 191S 10,000 s Dec. 24, 191S 10,000 6 June 9, 1916 12,000 7 Oct. 30, 1916 12,000 8 Feb. 23, 191 7 15,000 9 July 7,1917 15,000 10 Dec. X, 191 7 15,000 II Mar. 10, 1918 15,000 12 July 4,1918 15,000 Dr. Schifler gave the total debt at the end of 1918, as mk. 157.700 million of which about mk. 59,000 million vras floating." During the year 1919 the increase in the debt was about mk. 50,000 million, entirely in the floating debt. On March 31, 1920, the funded debt of Germany amounted to mk. 92,000 million, and the floating debt totaled mk. 105,000 million, according to a statement 'Addreaa at Weimar, April 9, 1919. Digitized by Microsoft® GERMAN PUBLIC FINANCE 139 of Dr. Wirth, Minister of Finance, to the Budget Committee of the National Assembly.^ The floating debt was mk. 132,100 million on June 30, 1920, and mk. 169,000 million on October 31, 1920. The total debt on September 18, 1920, was mk. 242,700 million, made up as follows: Million marks Funded debt 91,000 132,300 19,406 ■ Treasury bills Other bbligatibns. . . . '. . '. Total 242,700 To this must be added. the Prussian state debt of mk. 25,200 million, consisting of mk. 10,600 million of funded debt and mk. 14,600 million of unfunded debt, whicli the Empire assumed upon the surrender of the Prussian railways. The Empire also owed mk. 18,000 million to the states for expenses on relief and social work. The resulting grand total is mk. 285,90* million. Until the end of 1916, the floating debt was comparatively small, for it had been retired by funds raised in long-term loans. During the latter part of the war and after the signing of the armistice, the floating debt grew by leaps and bounds, because of the impos- sibility of raising adequate funds from the long-term loans. To the total debt must be added mk. 131,000 million to be paid to Germans as compensation for losses, such as seized property and merchant ships surrendered. Losses Under the Treaty of Peace ' Items Billion marks Surrender of the fleet 17.0 90.0 10.5 13s Delivery of war material 131 .o ' Frankfurter Zeitung, Dec. 23, 1930. London Economist, May i, 1920. 'Address of Herr Wirth to Cabinet, Sep. 23, 1920. Digitized by Microsoft® 140 INTERNATIONAL FINANCE AND ITS REORGANIZATION On May 31, 1921, the imperial funded debt was mk. 78,348 million and the floating debt was mk. 400,000 million. iv. Total Debt Analysed At the end of 191 8, the total debt was distributed among expenses approximately as follows:' Per cent ^0 18 Pensions 6 Compensation in invaded districts 3 Total 100 To the imperial debt should be added the debt of the federal states and of the local communities which on August i, 1917, amounted to 30,000 million marks and mk. 22,500 million, respec- tively. Analysis of the Total German Debt ' (in billion marks) Type Imperial debt State debt Munidpal debt, etc. Total debt Long-term 92.0 105.0 17. S I2.S 12. S 10. 127. 5 Total 197.0 30.0 22. s 249- S B. Loans i. The Theory of German War Finance The theory of German war finance grew out of pre-war con- ditions. Since the Empire lacked the legal authority to establish a broad base of taxation, the Ministry of Finance paid little heed •Estimates of George Bernhard, editor of Plutus, quoted in the London Economist, July 27, 1919. "Frankfurter Zeitung, May 14, 1920. Report of Consul Frederick Simpich, attached to the American Mission at Berlin, July 14, 1920. Digitized by Microsoft® GERMAN PUBLIC FINANCE I4I to the development of a tax policy. Furthermore legislation enabling the Reichsbank greatly to increase its note circulation and authorizing the establishment of emergency financial institu- tions made reliance on inflation the favored means of financing the war. The failure to impose taxes was justified as in France on the ground that it would have a bad effect on war morale of the public. Long-term loans and note inflation constituted the chief reliance of the Gferman Treasury. The theories of war finance of the three major European bel- ligerents afford some interesting parallels. Like France and Great Britain, Germany relied upon an increase in note issues. Like France, Germany expected a short war and deliberately postponed the financial adjustments until the end of the war. Neither adopted the British and American policy of "pay as you go" in part. Germany, unlike Great Britain, did not resort to heavy taxation at the beginning of the war. Unlike France, Germany did not rely on short-term financing to wage a supposedly short war. Until the fall of 1918, Germany issued long-term loans, at precisely timed intervals. She relied on short-term loans only when long-term loans could not be sold. Unlike either France or Great Britain, Germany in the very beginning of the war planned to meet her war expenses by an indemnity levied upon her enemies. An official statement of German policy was made in two addresses by Dr. Helfferich before the Reichstag on March lO and August 20, 1915. "The means of financing a modern war are substantially the following: First, the issue of loans; second, the use of the printing press for the issue of notes and paper money ; third, a reduction of expenses, and war taxation. . . . After the conclusion of peace, we shall present to our opponents a bill for the expenses of the war, forced upon us. We do not desire to increase by taxation the heavy burden which war imposes upon our people, so long as it is not absolutely necessary. Heavy taxes on consumption or increased transportation rates would be neither reasonable nor desirable with prices at their present level. The only method seems to be to leave the settlement of the war bill to the conclusion of peace and the period thereafter. Those who provoked the war, and not we, deserve to drag through the cen- turies to come the leaden weight of these billions." Digitized by Microsoft® 142 INTERNATIONAL FINANCE AND ITS REORGANIZATION ii. The Mobilization of Credit An Accessory to the Loan Policy In order to avoid a moratorium, and the consequent disorganiza- tion of the finances of the country, Germany relied upon fiat cur- rency and fiat credit for the purpose of creating liquid assets out of her capital goods and of facilitating subscriptions to the war loans.^" In mobilizing her credit resources Germany created four kinds of fiat money or credit, Darlehnskassenscheine, Reichskassenscheine, loans at war credit banks, and loans^ at municipal or cooperative loan bureaus. The theory of German war finance was that the Reichsbank resources were to be utilized by the Government and that special war-time institutions should be created for extending conunercial credit. The loan bureaus were authorized to furnish credit upon non-liquid assets, such as would not be accepted by a commercial bank. Against the pledges so deposited the Darlehnskassen issued notes, which were receivable for all public dues. Prof. M. J. Bonn in his "German War Finance" draws a parallel between the Darlehnskassenscheine and the British currency notes, but empha- sizes that the former were secured by large margins and were collectable by a levy against the entire property of the borrower. Reichskassenscheine, treasury notes, which were issued in 1874 to meet an emergency, and the outstanding amount of which was increased in 1913 from 120 to 240 million marks, were now made lawful money and the Reichsbank was relieved of its obligation to redeem these and the Reichsbank notes in gold. The four private note-issuing batiks of Germany were protected against the loss of their gold reserve by permitting them to redeem their notes with Reichsbank notes. Fiat credit was created by means of the war credit banks, which were organized throughout the country by the cities and commercial associations, by which the obligations of the banks were guaranteed and the losses refunded. These institutions extended loans against subscriptions to the war bonds, against merchandise, or against promissory notes. The Reichsbank discounted the bills of the war credit banks. "Bendix, Ludwig, Germany's Financial Mobilization. Quarterly Journal of Economics, pp. 725-744, August, 1915. Digitized by Microsoft® GERMAN PUBLIC FINANCE U3 Finally the municipal loan bureaus and the cooperative credit banks furnished loans in the smaller communities against collateral such as would not have been acceptable at the loan bureaus. Further to facilitate subscriptions to w^ar loans, the government made arrangements with the banks of the country to allow 4j^ per cent on deposits ear-marked for the loan, and arranged with the Reichsbank for the sale of war-loan treasury bills carrying a preferential rate of discount on the condition that the proceeds would be used to take up the war loan. The loan-bank notes were not an important factor in the sub- scriptions to the war loan. Although the volume of Darlehnskas- senscheine rose from mk. 1,317 million on December 3, 1914, to mk. 12,911 million on December 7, 191 8, the percentage of the war loans paid for by means of Darlehnskassenscheine declined as follows : Loan Per cent paid in Darlehnskassenscheine 1st 2nd 3rd 4th Sth 6th 7th 27.7 8.6 6.S 4.8 2.8 2.7 1-3 Apparently only a small amount of the loan bank notes were used in payment of war loan subscriptions.^^ iii. The Issue of Loans (a) The Restriction of Capital Issues — In order to insure the most favorable condition for the issuing of national war loans, Germany restricted the issue of securities for purposes not essential to the war. By an order of the Bundesrat, a special license was required for the formation of joint-stock com- panies or for an increase in their capital involving more than mk. 300,000.^^ "Holden, Sir Edward, Annual Report at the meeting of the stock- holders of the London City and Midland Bank, January 29, 1918, reprinted in the Statist, February 2, 1918. "Berliner Aktionar, November 7, 1917. Digitized by Microsoft® 144 INTERNATIONAL FINANCE AND ITS REORGANIZATION This legislation resulted in the marked decline in the number of new companies floated and in their capitalization. The number of new companies formed in 191 5 was less than half that of 191 4 and the capitalization was less than one-fifth. Capital Issues " Year Number of new companies Capitalization (million marks) 1913 1914 191S 1916 1917 (i yr.) I7S 119 58 89 26 216. 8r 322.22 S7-97 113.16* 47-13 After the war, the deferred issues were floated in great quan- tities. As a result of inflation, the amounts rose enormously. In 1920 the capital issues totaled mk. 11,514 million, or 100 times the 1916 amount. (b) Terms of Loans — The distinctive characteristics of the German loans were, the limited number of types of loans, the relatively constant issue price, the regularity of the interval between the issues, and the simul- taneous offering of bonds and treasury bills.during each of the loan subscription periods. The loans uniformly were redeemable at the option of the government after 1924 and the treasury bonds had definite maturity dates. The terms of the later issues permitted the government to redeem the entire issue of treasury certificates at a premium and the holder had the option of accepting cash or a certificate bearing a lower rate of interest, but redeemable at a higher premium. To facilitate subscriptions the government issued special treasury' bills in anticipation of loans. They matured on the day that install- ments fell due. Bank deposits earmarked for the loan bore a preferred rate of interest. The loans were issued in September and March from 1914 through 1918. Thereafter the government had to rely on short-term financing and the use of paper money until the tenth war loan was floated in the fall of 1919. The " For capital _ issues and listings on the stock exchange, see : Die Bank, and the Vierteljahreshefte zur Statistik des Deutschen Reichs. Digitized by Microsoft® GERMAN PUBLIC FINANCE US proceeds of the war loans were used to retire short-term obligations outstanding. The schedule of loans floated during the war is given here- with: German War Loans No. Date Type In- terest rate Price Maturity Redeem- able after— Amount in million marks Number subscrib- ers I Sept., 1914 Imperial loan . . . Treasury bonds.. S S 97. S 97.3 rgiS-ao 1924 3,881 1,000 1.177.233 2 Mar., 191S Imperial loan. . . Treasury bonds.. 5 5 98.S 98.5 1921-22 1924 8,331 77S 2,694,o6j 3 Sept., 1915 Imperial loan . . . 5 99.0 1924 12,160 3.966.418 4 Mar., 1916 Imperial loan. . . Treasury bonds.. 5 4S 98. S 9S.O 1923-32 1924 9.196 1,572 5,279.645 S Sept., 1916 Imperial loan. . . Treasury bonds.. S 4-5 98.0 9S.O 1923-33 1924 8,826 1.873 3,810,69s 6 Max., 19x7 Imperial loan. . . Treasury bonds. . 5 4.5 gS.o 98.0 1918-67 1924 13,122 7.063,347 7 Sept., 1917 Imperial loan . , . Treasury bonds.. S 4-5 98.0 98.0 1917-67 1924 12,626 5.213.373 8 Mar.. 1918 Imperial loan . . . Treasury bonds.. S 4-5 98.0 98. Q 1919-67 1924 14,766 6,510.278 9 Sept., 191S ToUl.... Imperial loan . . . Treasury bonds.. S 4-S 98.0 98.0 1919-67 1924 10,434 3.7i7.6s» 98,563 From the sixth to the ninth issue, treasury certificates were redeemable by drawing in series in January and July at IIO. Treasury certificates not drawn for payment by lot are neither redeemable nor convertible into other issues until 1927 when the government has the option to redeem the oufetanding amount at par. If the government exercises this option, the holder may obtain cash or 4 per cent treasury certificates redeemable at 115. Ten years later the government reserves the right to call the then out- standing 4 per cent treasury certificates, in which case the holder may obtain cash or 3j^ per cent treasury certificates redeemable by drawings at 120. Thereafter the government has no further right to redeem or offer conversion privileges. The certificates mature July i, 1967, on which date certificates outstanding shall be paid at no, 115, or 120 according as the certificates bear 4j4, 4. or 31^ per cent interest. Digitized by Microsoft® 146 INTERNATIONAL FINANCE AND ITS REORGANIZATION (c) The Lottery Loan — Subsequent to the cessation of hostilities German credit was so badly shaken that it was impossible to float a long-term loan. The financing after the armistice was in the form of short-term bills and increases in paper circulation. In order to reduce the paper circulation Erzberger, the Minister of Finance, undertook to issue a lottery loan in November, 1919. The amount offered was mk. 5,000 million payable one-half in cash and one-half in 5 per cent war loans. No annual interest was payable, but instead a bonus of 5 per cent per annum which is payable when the certificate is drawn for payment. Drawings will be held twice yearly for eighty years. The prizes will be 2,500 in number and mk. 25 million in amount, and will vary from mk. 1,000 to mk. 1,000,000. At the end of twenty years, subscribers may demand payment, at the face value plus accrued interest. ' The lottery loan was not a success. The ninth war loan brought in subscriptions of over mk. 10,000 million, whereas the lottery loan* procured only mk. 3,818 million. The loan did not appeal to the investing public because of the other speculative opportunities at hand. Over 79 per cent of the total number of subscriptions was obtained from investors in one or two shares. The loan did not accomplish the object of reducing the floating debt, which increased from mk. 80,200 million to mk. 83,100 million during the very period of subscription. The recognition of the poor condition of the national credit led to the proposal to float a lottery loan and its failure demonstrated the collapse of German credit at home. C. War-Time Taxation i. Taxation Policy Before the war, a special levy was imposed for military pur- poses, the Wehrbeitrag, a non-recurrent tax on property and income in 1913. But the carefully prepared plans of financial mobilization did not include provisions for war taxes. In fact, an expected short and victorious war, the expenses of which were to be paid by an indemnity, should not require any extensive taxation. The Empire and the federal states raised loans and increased their debts, but in the early period of the war did not cover the growing interest Digitized by Microsoft® GERMAN PUBLIC FINANCE I47 charges. The prolongation of the war made the delay in levying taxes embarrassing. Whereas in 19 13 the total taxes constituted 81.8 per cent of total expenditures, the ratio in the calendar year 1914 was 27.8 per cent, and in 1915 the ratio was 6.9 per cent. In 1916 the deficit in the ordinary budget, excluding military ex- penses, was about 480 million marks. The 191 7 -budget showed a deficit of 1,250 million marks, and the 1918 budget a deficit of 2878 million marks.^* The government subsequently enunciated the policy that, whereas, the expenses of the war would be financed through the issue of bonds and treasury notes, the ordinary or current expenses, including the interest on the war debt, would be met by taxation. At first the tax measures adopted were makeshifts and were to last during the war only. However, as the budget needs grew the government was compelled to undertake a thorough-going program of financial legislation. ii. Principles of Taxation The freedom of the Imperial Government in formulating a tax policy was restricted by political considerations, the reservation of income taxes to the federal states.^^ The failure of the Empire to levy direct taxes or taxes on personal incomes during the early part of the war, and its reliance on indirect taxes were severely criticized by the liberal papers, who lauded the British tax scheme for its justice to the working classes. The opposition in Germany to an Imperial income tax was due to the junkers' fear of its liberal use by the popularly elected Imperial Reichstag and their confidence in the undemocratically constituted diets of the federal states. iii. Taxes Enacted ^' (a) fFar Increment Tax — The Imperial war tax of June 21, 1916, was a tax on property increments during the years 191 5 and 1916. "Program of New Imperial Taxation. British Board of Trade Journal, May 9, 1918, p. 584. Count von Rodern's budget speech, April 17. 1918- "'Zimmerman, F. W. R., Die Finanzwirtschaft des Deutschen Reichs. Berlin: 1916. " Ballod, Karl. Die Reichssteuervorlagen von MSrz, 1916. SchmoHers Jahrbuch, 1916, xl, pp. 977-990. Digitized by Microsoft® 148 INTERNATIONAL FINANCE AND ITS REORGANIZATION The taxes applied to persons whose property had not varied even by lo per cent during this period. The tax was in effect a property tax rather than an increment tax. The Act of April 9, 1917, supplemented the extraordinary non-recurring war levy and increased its yield by 20 per cent. On July 6, 191 8, a levy on excess income and on property was imposed to cover the increase between the valuations in 1914 and 191 8. Increases of income of less than mk. 3,000 were exempt. For the first mk. 10,000 of increased income the tax was 5 per cent, for the next mk. 10,000 10 per cent, for the next mk. 30,000 20 per cent, for the next mk. 50,000 30 per cent, for the next mk. 100,000 40 per cent, and for additional amounts, that is, above mk. 200,000, it was 50 per cent. The property tax was also graduated. Properties under mk. 100,000 were tax exempt. The rate was graduated from i per 1,000 on the first mk. 200,000 up to 5 per 1,000 on properties ex- ceeding mk. 2 million. (b) Company Profits Tax — The Act of June 16, 1916, required taxable corporations to form a war reserve of 60 per cent of the excess profits earned. (c) Other Federal Taxes— A series of acts passed in June, 1916, provided for increases in postal and telegraph rates, in taxes on tobacco and tobacco products, on railway rates and bills of lading, and for a tax on sales of over mk. 3000 at the rate of one per mill. As the need for revenue increased the Reichstag passed further tax measures with record speed in March and April, 19^7. The sum of mk. 100 million of the profits of the Reichsbank was made payable to the government. Furthermore, the stamp tax, imposed for a limited period, was extended until the year 1920. Freight and passenger rates were further raised by 10 to 16 per cent on all commodities except coal. The coal-production tax, a very lucrative source of revenue, sub- jected all coal, domestic or imported, to a tax of 20 per cent ad valorem, except that coal used in homes was taxed only 10 per cent. Digitized by Microsoft® GESMAN PUBLIC FINANCE Z49 (d) Non-Federal Taxes — From the beginning of the war, the States and municipalities had to bear a share of the war burden. As a result, the states in- creased their income-tax rates. Few new taxes were laid. By statute, the increase of taxation by the federal states applied auto- matically to many municipal taxes and therefore the municipalities did not have to exercise independent powers of taxation to any great extent. D. The Budget " i. Total Requirements For 1918, the budget requirements were mk. 7300 million, and for 19 1 9, mk. 17,500 million.^^ The expenditures for 1919 were as follows: Items Billion marks Service of the debt Pensions 4.3 1-7 Administration Other expenses Total 17s The estimated deficit was mk. 10 million. In addition to the federal budget, the several states had expenditures of mk. 6 million. The 1920 budget called for revenues and expenditures three times as great as in 19 19. The expenditures of the Empire were mk. 5S,6oo million and the revenue mk. 29,000 million. The expenditures included ordinary expenditures of mk. 28,000 million and extraordinary expenditures of mk. 11,600 million. In addition the deficit in the postal and railway service was over mk. ibfXO million. " Statistlsches Jahrbuch, sec. xv, FinanEwesen, gives a five-year record of the budget. The Reichshaushalts-etat gives the details of the budget. "Budget address of Dr. Schiffer, Minister of Finance. Weimar, April 9. 191?- Estimate submitted by Finance Minister Erzberger, Commerce Raport*, November n, 1919. Digitized by Microsoft® IS© INTEKNAXIONAL FINANCE AND ITS REORGANIZATION Budget fob 1920 Items E:qpenses: Commonwealth debts Pensions, allowances to disabled and to widows Medical treatment of wounded soldiers Other expenses on soldiers Food subsidy Military and Navy budget For miscellaneous purposes Total Extraordinary Budget: Payments under the Peace Treaty Demobilization of the army and navy Expenses of prisoners of war Riot damage Sundry Deficits of postal service and railways Total Grand total budget Estimated Revenues of the Regular Budget: Revenues from administration Direct taxation and taxes on traffic Duties and consumption tax Other direct taxes Revenues from banks and from export duties. . . Revenues anticipated from new taxes Total Billion marks 12.4 3-9 i.i 30 30 19 2.7 28 .0 s 2 I I I 2 16 S 27 6 ss 6 10 2 8 9 3 2 I 2 9 29.0 The budget was subsequently revised to yield mk. 39,890 million. The revenue was derived chiefly from the income tax, the coal tax, the sales tax, and customs revenue. The final figures for the year 1920 indicated a revenue of mk. 27,720 million, expenditures of mk. 102,576 million, and a deficit of mk. 74,855 million, met by an increase in the floating debt. ii. Deficits. The deficit of the 1919 budget increased as the year advanced and exceeded the estimates. The 1920 deficit amounted to mk. Digitized by Microsoft® GERMAN PUBLIC FINANCE 151 26,600 million in the early budget proposals. On September 23, 1920, Herr Wirth estimated the 1920 deficit at mk. 55,700 million, and at the end of the year the deficit seemed to be mk. 74,855 million. Ordinaky Budget Revenue for 1920, Revised Items IV^illion marks Direct Taxes: Corporation tax 900 1,300 100 Tax on interest and dividends ProDertv tax Total direct taxes 14,920 3,650 4,000 2,500 Indirect Taxes and Monopolies: S^es tax Coal tax Customs revenue 400 630 Railway tax Beer tax 130 250 100 Champagne tax Brandy tax ,320 Soo Soo Matches tax 1,850 35° 2,420 Miscellaneous revenue 17,970 2,S0O 4,Soo Emereencv lew Grand total 39,890 The extraordinary budget consisted of the expenditures inci- dental to the execution of the terms of the Treaty of Peace and were larger than estimated. The actual expenditures for the year 1919 and up to July 26, 1920, and estimated expenditures for the Digitized by Microsoft® 353 INTESNATIONAL FINANCE AND ITS BEORGANIZAXION two-thirds of the year ending March, 1921, totaled mk. 53,685 million, apportioned as follows: Milb'on marks Annv of occuDation. leDaiation Gommission. etc 14,900 Disarmament 5,200 Restitution sSs 25,540 Damages owing to Uquidation of property and compensation 7,480 Total 53,68s The origin of the deficit is the same as in the other countries of Europe. The issue of paper money raised all prices, including the cost of administering the government. The continuous issue of paper money increased prices and widened the gap between revenue and expenditure. Then to bridge it, the government issued more paper money. To keep the price of necessities down, the Imperial government granted a food subsidy of mk. 3000 million for the year. Further- more, in spite of an increase of 400 per cent in postal rates, the postoifice department showed a deficit of mk. 2000 million. The railroad deficit amounted to over mk. 16,000 million. Before the war the income from railroads made it possible to reduce the national debt. In 1913 the surplus of the railroads was about mk. 325 million, but it decreased during the war and in 191 7 amounted to only mk. 18 million. In 1918 a deficit of mk. 1325 million appeared. The Prussian railroads before the war were appraised at about mk. 7,000 million. In criticism of the amount of the budget deficit, mk. 76,000 million, the French experts on the Reparations Commission pointed out that whereas the budget estimate of expenses necessary to execute the Peace Treaty was mk. 42,000 million, the amount actually expended was only mk. 17,000 million. The railroad deficit was due in part to the fact that the personnel was increased by over 350,000 employees since the pre-war days, and the em- ployees in the postal service were several times as numerous as in 1919. The expenses of the several ministries increased greatly over the 1919 figure. For instance, budget estimates for the Ministry of the Interior in 1920 were mk. 1,433 million as against mk. Digitized by Microsoft® GERMAN PUBLIC FINANCE 153 19 million in 1919. The figures for the Ministry of Foreign Affairs were mk. 295 million in 1920 and mk. 24 million in 1919. iii. Budget Comparisons The pre-war budget of Germany amounted to about mk. 3500 million, the 1920 budget amounted to mk. 55,5CX) million, or over fifteen times as much. The service of the debt in 1913 amounted to mk. 238 million, and in 1920 to mk. 12,400 million, an increase of 52-fold. The debt service in 1913 constituted 6.4 per cent of the total budget and in 1920 it was 22.4 per cent. The interest on the debt in 1920 was 3.4 times the total expenditures of the 1913 budget. Pke-War Budget, Fiscai Year Ending March 31, 1914 Items Expenditures for: Imperial debt Army Navy Post and telegraph Railways Pension fund Treasury Miscellaneous Extraordinary Total Revenue from: Treasury Post and telegraph Railways Miscellaneous Extraordinary Total Million marks 237.8 775-9 197.4 699 -3 108.7 142-5 114-3 1301 - 5 118. 6 3696.0 2489.0 842 . 4 153-8 92.2 118. 6 3696.0 The pre-war income of Germany was about mk. 45,000 million, a sum less than the present annual budget. Indeed, inflation de- stroyed the significance of this comparison. It changed the mone- tary unit in which the comparison is expressed. Inflation lightened the burden of the war and deflation will increase it, if the debt is paid. , » Digitized by Microsoft® 154 INTERNATIONAL FINANCE AND ITS REORGANIZATION That the raising of the German national revenue already bears heavily upon the individual taxpayer is evident from an estimate prepared by Mr. Dumont, Chairman of the French Budget Com- mittee, who calculated the per capita tax of the several belligerents, which is given in dollars at parity as follows: In Germany $I7S> in England $105, in France $91, in America $50, in Italy $45.^' The figures submitted by Austen Chamberlain in the House of Commons likewise indicates the burden on the German taxpayer. However, since the conversion into sterling is at mint parity, allow- ance must be made for the varying degrees of inflation of the currency. Direct Taxes per Capita Country- 1913 s. d. 1920 s. d. Ratio of 1920 to 1913 taxes. Per cent Italy 12 6 13 6 31 32 10 43 3 47 303 4S2 7 346 348 977 1379 England Germany A more accurate measure of the burden of taxation is the per- centage of income paid in taxes. In England, the lower classes pay in both direct and indirect taxes between 7 and 8 per cent of annual earnings, whereas in Germany, the same class would pay about 16 per cent. The relative rates of taxation in the higher income classes is likewise greater in Germany. Relative Income Tax Rates '" (conversions at parity) Amount Paid in Germany Paid in England of income. Marks On earned income. Per cent On unearned income. Per cent On earned income. Per cent On unearned income. Per cent 50,000 100,000 300,000 26.1 33-6 4S-7 32s 39- 1 SO. 2 7.S iS-7 23 2 2° 18.7 239 '" Frankfurter Zeitung, May 14, 1920. "Frankfurter Zeitung, September 22, 1920. Digitized by Microsoft® GERMAN PUBLIC FINANCE ISS E. An Appraisal of German War Finance Before the war the debt of the states and provinces grew as a result of social legislation. The debt of the Empire alone, excluding that of its political subdivision, was about one-sixth that of France, about one-third that of Great Britain, and slightly less than the national debt of the United States. i. The Debt The German fiscal policy during the war was based on a wrong theory, — that the indemnity levied upon the enemy would refund the war debt. But unethical as the aim was, German war finance was well organized. The loans were issued at definite intervals. The rate of interest was constant and the yield fairly so. The securities were of a uniform type ; there was no need for diversifica- tion of types of war loans as in France particularly and even in Great Britain, in order to attract subscriptions. The loans were re- deemable in about lo years. This feature showed financial foresight. Until the collapse of Germany, the floating debt constituted a small percentage of the total debt, in striking distinction to that of France and even of Great Britain. At the end of 1918, when the total debt was mk. 139,000 million, the floating debt was mk. 40,000 million. The failure of German credit after the armistice raised the floating debt to mk. 92,000 million out of a total debt of mk. 197,000 mil- lion. With the exception of a small loan in the United States, soon repaid, and loans in the neighboring neutral countries, the foreign debt of Germany was practically nil. The German students of finance pointed out that internal loans had an ad- vantage over external loans in that the proceeds were spent at home, that there was no burden through the payment of interest to foreigners, and the entire national production and savings were devoted to the war.^^ However the Germans made a virtue of a necessity. External credits have no value if foreign supplies cannot be imported from the lending country. The blockade made external loans useless to Germany. Strong inducements practically compelled subscriptions. For instance a portion of the salaries of all public officials was retained "Bonn, M. J., German War Finance, Chaps. II, III. Digitized by Microsoft® IS6 INTERNATIONAL FINANCE AND ITS REORGANIZATION for the purchase of war scrip. Soldiers were offered ten days' leave for every mk. 500 they subscribed. Treasury bills, the proceeds of which were to be devoted to the loan, bore a preferential rate of discount, as did also bank deposits ear-marked for the loan. Savings banks waived the usual notice of withdrawal in favor of subscribers to war loans. Loan banks offered loans at low rates of interest, to borrowers subscribing to war bonds. Municipalities offered to investors in their securities an exchange of holdings for national war bonds.^^ Attractive features were added to the later loans. The sixth loan was made redeemable at a premium by lot. Bonds drawn would be paid at no, and undrawn bonds converted into bonds bearing lower interest would be redeemable at further draw- ings at 115 or 120. War loans were raised by dangerous financial methods. Official instructions to subscribers to the third war loan reveal the pyramid- ing of German credit. "If you have already subscribed to the first and second war loans and paid in full for the same you can par- ticipate in the present issue. All you need to do is to take your stock or the receipt for the amount paid, to a bank which will advance you 75 per cent of the nominal value, so that, if you have mk. 400 of old war loan you can subscribe mk. 300 in the new issue without paying a single pfennig. You can even subscribe four times this amount, or mk. 1,200, if you also leave with the bank the stock that you take in the new loan in which case you will have given the bank as security 400 mk. of the old war loan and mk. laoo of the new war loan, together mk. 1,600, against a loan of mk. 1,200."** Similar methods were adopted for attracting subscrip- tions from neighboring neutral countries. In Denmark, for example, German bonds of mk. 1,000 were offered in exchange for Danish gold, and by depositing these bonds at the bank and paying mk. 500 additional, the purchaser received a second bond valued at mk. 1,000. By depositing the second bond and paying another mk. 500 he received a third bond for mk. 1,000. He thus became the holder of three German bonds of an aggregate principal value of mk. 3,000 which cost him mk. 2,000.** The evils of the excessive reliance upon loans to finance the "Jennings, H. J., Germany's Financial Outlook, Nineteentn Century, February, 1918, 375-6, "Koeinische Zeitung, September 2, 191 j, quoted in New York Nation, March 8, 1917. " Nineteenth Century, id,, p. 378. Digitized by Microsoft® GERMAN PUBLIC FINANCE IS7 war manifested themselves in increasing debt charges, and in the rising cost of administering the government and in the rise of the cost of living. When the budget was no longer adequate to pay the service of the debt, vigorous taxes became necessary, and to apply them suddenly was a difficult matter. The German loan policy broke down as a result of the pro- longation of the war. It was carefully conceived to meet the needs of a short war. But it produced all the results of inflation and was condemned finally by German officials and by students of finance. In the words of Dr. Bernhard Dernburg "The financing of the war has really not been effective. . . . We are able to balance the budget by leaving the whole of our military expenditures out of the ordinary estimates and by entering it as an extraordinary war expenditure. We have a new debt to the amount of mk. 100,000 million and for the service of this debt we need about mk. 7,000 million. But in this direction practically nothing has been done." ii. Taxation The original theory advanced by the Ministry of Finance was that war taxation would not be levied. However, the need for balancing the budget compelled a change of policy. Taxation was to be levied, but only to meet the interest charges on the war debt. There was delay not only in passing tax legislation but also in putting it into effect, notably in the case of the war profits tax. The limitations of the old German constitution made an elastic system of imperial taxation impossible. Toward the end of the war a vigorous taxation policy was introduced, but it was too late to avert the effects of the earlier loan policy. During the five years 1914 to 1919 even the interest charges on the debt were not com- pletely covered by revenue. In other words, the interest on the mounting debt was paid in part from loans. F. Taxation After the Armistice ^^ The characteristic of the post-armistice tax policy has been the emphasis on direct taxation. As a result of the republican constitu- tion the tax policy of Germany was changed and the Empire was "Berliner Tageblatt of April aS, 1930, gives the official text of these laws. Digitized by Microsoft® IS8 INTERNATIONAL TINANCE AND ITS REORGANIZATION endowed with the right to levy direct taxes. The relevant articles of the constitution are given herewith: Article 8. The government further possesses legislative power over taxes and other sources of income, insofar as they may be claimed in whole or in part for its purposes. In the event that the government claims taxes or other forms of income which formerly belonged to its confederated states, it will be bound to consider the maintenance of such states' vital means of support. • • • • Article 15. The government administration exercises supervision in matters over which the nation has the right of legislation. Insofar as the laws of the government are to be exercised by state officials, the government administration may issue general directions. It has the power to send commissioners to the central authorities of the state, and with their approval to subordinate officials to supervise the fulfilment of the government laws. • ••••••• Article 84. The government shall provide by law for: X. The organization of the administration of taxes in the different states so far as shall be required for the unified and regular fulfilment of the national tax laws. ... 3. Adjustment accounts with the confeder- ated states (are provided for). The unification of state and imperial taxation was effected by the Reichsabgabeordnung or national levy ordinance. It stipulates the proportion of the proceeds of the various imperial taxes which the federal states and the communities are to receive. In future only the Republic will collect taxes on income, on property and on inheritances. The former income tax of the federal states had a fixed rate but the new imperial income tax has a graduated rate.^' The federal states will receive a share of the income tax on the principle that revenue from the low rates would have been paid mostly to them and revenue from the supertaxes to the Republic. They will receive go per cent of the taxes on incomes under mk. 15,000, and so on in decreasing ratios until 20 per cent of the taxes ■ on incomes over mk. 400,000. The new law provides that each state or municipality shall receive from the revenues of the national income tax an amount equal to the average annual revenues from the local income taxes during the previous three years. The administration of the tax system was centralized and put in charge of officials of the Empire. The Minister of Finance will administer all taxes. Cooperation of state and local tax officials is provided for. Furthermore, the "Berlin correspondence, London Economist, Dec. 6, 1919, Digitized by Microsoft® GERMAN PUBLIC FINANCE 159 Empire will assume the burden of certain expenditures which though local in form are national in character. i. Indirect Taxes The sales-tax rate was raised in 1919. Practically everything, except the most essential goods, was taxed from i per cent up to IS per cent, depending on its character. Of 19 groups of luxuries II were subject to a 15 per cent tax. Sales for export were exempted from the tax.' Two methods of collection were followed, in some cases a tax on the sales price of the article and in some cases a tax on the total turnover of a retail merchant. In February, 1920, for the first time since August, 1 91 4, the Ministry of Finance published an official summary of the national revenue. The Deutsche Allgemeine Zeitung of July 9, 1920, comments that "the possibilities of following up the development of economic conditions in Germany and of forming a correct judg- ment were hampered by the lack of sufficient and accurate data. One had to rely on figures that, now and then, slipped into the public press." The total revenues for eight months ending Janu- ary 31, 1920, amounted to mk. 6,025 million. The estimated amounted for the year ending March 31, 1920, was mk. 13,542 million. The sources of revenue were as follows: Extra war tax Coal tax Duties Turnover tax Tobacco tax Stamp dues (on legal papers) Railroad revenues Wine tax Numerous other taxes. . ; . . Total Per cent 16.8 16.6 10.8 9.8 9.8 9.6 7-7 S-2 13-7 lOO.O The heavy taxes on income any property were passed in the spring of 1920 and do not show in the above list. The receipts for the fiscal year 19 19 were obtained from a great variety of sources, from custafciTs duties, from taxes on tobacco and cigarettes, on sugar, on salt, on the manufacture, import and con- sumption of alcohol and its pfoduclls, on the consumption of vinegar, Digitized by Microsoft® l6o INTERNATIONAL FINANCE AND ITS REORGANIZATION wine, champagne, mineral water, and beer, on illuminants, on matches; from stamp taxes on playing cards, on invoices and bills; stamp taxes on contracts, securities, dividend warrants, lottery tickets, private or governmental, bills of lading, directors' fees, sales of merchandise, transfers of real estate, insurance; from taxes on coal, on the purchase of real estate, on sales, on postal and tele- graph service; from the property tax, inheritance tax, war surtax to 1 916, extra war tax of 19 18, war tax of 1919, commonwealth emergency sacrifice tax {Reichsnotopfer) , and tax on increase of property. ii. Direct Taxes on Income and Profits {a.)Taxes on Income — The income tax became effective April 14, 1920, and applies to the income of individuals. The tax is payable to the Empire only. All Germans are subject to this as well as foreigners deriv- ing an income from property or business in Germany and aliens domiciled in Germany longer than six months. Taxes are levied on income from business capital, labor, and any other receipts including non-recurrent profits. Exemptions of mk. 1,500 are granted to each tax-payer and mk. 300 for each dependent person in his household. Inheritances, insurance payments, business expenses, interest on debt, charitable contributions and business losses are deductible. From 10 per cent on the first mk. 1,000 of taxable income, the rate rises by increases of i per cent on each mk. 1,000 up to mk. 25,000 and ultimately by graduations of I per cent on each additional mk. 50,000. The actual rate on the entire income is as follows for a few selected classes of income: Tax on unmarried Tax on married with 5 children Income Marks Marks Rate per cent Marks Rate per cent 2,000 SO 2.S 4,000 270 6-7 , 6,000 53° 8.8 SO 0.8 10,000 1,170 11.7 67s 6.7 50,000 13,060 26.1 10,980 22.0 100,000 33,62s 33.6 3a,27S 32-3 500,000 2S2.1IS SO- 4 2S0,34S SO. I 1,000,000 SSa.ioo SS-2 SSo,3oo SSO Digitized by Microsoft® GERMAN PUBLIC FINANCE l6l The effect of inflation was to increase many incomes lo to 15 fold and thus to raise the rate of taxation. A man with a pre- war income of mk. 2,000 had to pay mk. 50 or 2.5 per cent, but out of his post-war income of 20,000 marks he had to pay mk. 2,000 or 10 per cent. (b) Tax on Income from Investments — This tax applies to income from accumulated capital, or, as the British term it, unearned income. Tha law went into effect on March 31, 1920. The tax applies to the income from invested capital such as dividends, interest, royalties, profits from every kind of participation in business, claims and mortgages. Germans, non-Germans domiciled in Germany, and domestic corporations are required to pay this tax on the income from their foreign invest- ments. The exemptions from this tax include the income of sav- ings banks, cooperative societies, insurance companies, universities, and religious and charitable institutions. This tax does not apply to the premium war loan and other loans enjoying tax-exemption. The tax rate is 10 per cent and is paid at the source, i. e., the debtor pays the tax within one month from the amount due to a creditor liable to the tax. To prevent evasion, a law was passed permitting banks to accept dividend warrants only if the entire bond or certificate is deposited with them. (c) Tax on War-time Increase of Income — This tax, also known as the extraordinary war tax, went into effect on September 10, J 919, and applies to the excess of income in the fifth year of the war over the pre-war income. Individuals and corporations are liable to this tax. The amount taxable is the difference between the income for 1919 and the income for 1914, which as a minimum must have been mk. 10,000 or over. Corporations are taxed on the difference between the profits of the two years. War incomes of less than mk. 30,000 or income increases of less than mk. 3000 are exempt, as are ^so increases of corporation profits of less than mk. 5000. "Tht rates of taxation applicable to individuals range from 5 per cent on the first mk. 10,000 of increase up to 70 per cent on increases of over mk. 200,000. Increases of corporate profits are subject to an 80 per cent tax. The law recognizes the severity of this tax and makes adequate provisions for the modifi^iiation of the assessments, for the Digitized by Microsoft® l62 INTERNATIONAL FINANCE AND ITS KEORGANIZATION limitation of this tax in case 90 per cent of the total increase in income is taken by a group of specified taxes, including this. If necessary the tax-payer will receive credit on a 5 per cent basis to pay this tax. According to a previous law effective July 26, 1918, corporations had to pay a tax on the increases of profit made in 1918 at the rate of 60 per cent of the increase.^^ (d) Tax on Corporate Profits — This tax, applicable to the income ot corporations, corresponds to the income tax on individuals. The tax, effective April 15, 1920, is levied on the entire profits, and consists of a normal tax at the rate of 10 per cent of the income and a surtax which varies from 2 per cent on the amount of the dividends when 4 per cent dividends are paid up to 10 per cent when dividends of over 18 per cent are paid. Corporations exempted include political bodies, states and municipalities, universities, charitable and other like institutions, and pension banks. Hi. Property Taxes In addition to the several taxes on income, on war-time increases of income, and on corporate profits, a series of property taxes was levied. The law of July 26, 191 8, taxed property on the valua- tion of December 31, 1916, exempting the first mk. 100,000. The rate varied from i per mille on the first mk. 200,000 of taxable property up to 5 per mille on property in excess of mk. 2 million. The war-wealth levy and the capital levy are treated elsewhere. (a) Recurrent Levy on Increases of Wealth — In addition to the non-recurrent levy on the increases of wealth during the war, the Reichstag passed a bill (April 21, 1920) pro- viding for recurrent taxation on the increases of wealth at intervals of three years. Increases of less than mk. 5000 and properties of less than mk. 20,000 were exempted. The rates vary from i per cent on the first mk. 10,000 of the taxable increment to 10 per cent on the taxable increment above mk. 300,000. Under the tax an increase of mk. 6000 will pay mk. 10; an " Koeluische Zeitung, September 29, X918. Digitized by Microsoft® GERMAN PUBLIC FINANCE 163 increase of mk. lo,ooo will pay mk. 50; of mk. lOO.OOO, mk. 2800; and of mk. i million, mk. 82,000."* This law replaced Herr Erzberger's proposed, but abandoned tax on expenditures under which the government would tax not income or production but consumption, or all personal expendi- tures above a given figure. (b) Inheritance Tax — This tax in effect September I, 1919, taxes legacies and dona- tions to natural persons. Germans and foreigners living in Ger- many are subject to the tax. The law exempts household goods up to mk. 50,000 and also mk. 20,000 of an estate of less than mk. 200,000. Furthermore, legacies of less than mk. 500 are exempt and in cases of bodily injury of the legatee or other good cause the whole legacy is exempt. Deductions are allowed of the debts of the testator as well as unpaid taxes. The rate of taxation varies according to the amount of the legacy and the grade of relation- ship between the testator and the legatee, which is classified. Six degrees are recognized. On the first taxable mk. 20,000 willed, the tax varies from 4 per cent to 15 per cent depending on the degree of relationship. Above mk. 150,000 of inheritance the tax varies from 8 per cent to 30 per cent. iv. The Effect of Heavy Taxation Taxes in Germany, as shown above, are heavier than in any of the major belligerent countries. What a burden it is upon the individual may be seen from typical cases. After the war a tax- payer retaining his pre-war capital of mk. 1,000,000 and an annual income of mk. 50,000 must pay mk. 244,250 under the emergency levy. His income is thus reduced to mk. 37,787 of which he has to pay an income tax of mk. 8931 and a tax on investments* ol mk. 3778, leaving a net income of mk. 25,078. This is subject to a long list of indirect taxes which have been given above. A taxpayer whose pre-war capital was mk. 2.5 million and who doubled it during the war must pay mk. 2,328,030 war- wealth levy and mk. 1,004,500 under the emergency levy. Of the remaining income, he must pay income tax of mk. 26,439 and a "Berlin Correspondence of the London Economist, Marcli 9, 1920. Digitized by Microsoft® 164 INTERNATIONAL FINANCE AND ITS REORGANIZATION tax on income from investments of mk. 8337. His net income after paying direct taxes is mk. 48,599 as compared with a pre- war income of mk. 125,000 or an income before the direct war taxes were enacted of mk, 250,000. Indirect taxes would diminish the net income further. (a) The Flight of Capital— Prior to the military collapse of Germany and also after the signing of the armistice, rumors were afloat that the government would resort to repudiation. These rumors upset the market for war bonds. As a result the government issued a proclamation that it did not intend to confiscate bank deposits, or money or securities of any description, that it did not intend to invalidate any of the war loans and that it would not interfere with pensions and other legal claims of soldiers, widows or orphans. It did unequivocally affirm its intention of levying heavy taxation on incomes and property. As a result of the heavy taxes, proposed and enacted, German Capital fled to the neighboring neutral countries. Bonds owned in Germany were sold at a sacrifice. Even German currency was converted into foreign currency. It was estimated that by the middle of 191 9 about 4 or 5 billion marks had been sent to Holland. The Frankfurter Zeitung estimated that about mk. 35 billion of German capital had "escaped" into Switzerland from the date of the armistice to the middle of 1919. German capitalists bought banknotes of foreign countries extensively, apparently for the purpose of evading taxation. The purchases of large denomina- tions of dollar and sterling notes, not usual as a trade practice, continued throughout the early part of 19 19. Even ruble notes were bought at rates higher than prevailed in other countries. (b) The Effects of the Flight of Capital— The sale of marks and the purchase of foreign currencies caused a slump in German exchange rates. In turn the price level in Germany was depressed below the world's level and goods became very cheap. Foreign purchasers rushed to buy goods and drained Germany of her meager supply of commodities. German writers called this bargain sale "Deutschlands Ausverkauf." (This sub- ject will be treated further under the section on foreign exchange.) Digitized by Microsoft® GERMAN PUBLIC FINANCE 165 (c) Counter Measures — To overcome the efEects incidental to a program of heavy taxa- tion, various measures were proposed and enacted, such as the official assurance that repudiation w^ould not be resorted to, the proposal to restrict emigration, the control of the export of capital, the abortive proposal to issue new currency, and the control by banks of the payment of interest and dividends on securities. 1. The Restriction of Emigration. — Increasing taxes in- duce evasion. The comparatively moderate increase in taxation before the cessation of hostilities made it necessary to consider means to prevent evasion. A bill in the Reichstag provided that persons that had a permanent residence in Germany and desired to emigrate should be liable for the payment of taxes for a period of 5 years after the conclusion of peace, on the theory that those who enjoyed the protection of the German army should pay the costs. Those exempt from the tax included persons whose property did not exceed mk. 30,000, persons who emigrated in the interests of Germany, and persons involuntarily detained in Germany. Those liable to the tax must leave 20 per cent of the taxable property as security in the event of their emigration.^® 2. The Control of the Export of Capital. — ^The flight was to be checked. Investments of money abroad were prohibited by a decree of November 21, 1918, which was amplified by another dated January 15, 1919, to the effect that anyone who between July 1, 19 1 8, and the date of the first decree had sent any securities abroad by any means other than a bank must notify the Property Tax Office. The banks in turn must similarly notify this office of the transfer^of money or securities abroad to be held in trust by a foreigner or to be credited to him. The export of goods of great value or of works of art must be reported and the contents of registered letters declared. To prevent the smuggling of banknotes out of the country the regulation of foreign bills was made more stringent. Only mk. 50 per day and mk. 150 per month were permitted to be sent .abroad without a license. Prior to December 18, 1918, the limit was 1000 marks per day and mk. 3000 per month. An act of "Koelnische Zeitung, April 19, 1918; alao British Board of Trade Journal, May 23, 191S; Commerce Reports, June 15, 1918. Digitized by Microsoft® l66 INTERNATIONAL FINANCE AND ITS EEOEGANIZATION March i, 1919, forbade, under penalty, traffic in German bank- notes. Frontier guards were strengthened to make the law effec- tive."' 3. The Issue of New Money. — ^The existing currency was to be demonetized. To prevent the evasion of taxes the Ministry of Finance proposed to withdraw all paper money and to replace it by bonds or emergency paper. The latter was to be exchanged for new money, when issued, and the old paper money would be declared invalid. To avoid trouble, holders were advised to deposit their money in banks. Preparation was also made for exchange over a Counter. A list of holders and the amounts was then to be trans- mitted to the tax office. These measures aroused great protest. The difficulties of the plan were many. The length of time for registration and stamp- ing of the billions of currency outstanding would be very great. The proposed issuance of temporary currency until a new series could be prepared would be a temptation to wholesale forgery. The measure was therefore abandoned.^^ 4. Bank Control of Income from Investments. — ^The aid of banks was enlisted. The fear of the proposal to stamp money in- duced people to invest in securities. When the plan failed, the gov- ernment attempted to trace the property and income of its citizens through the registration of securities. Regulations were issued whereby coupons and dividends could be collected only through banks and bankers. In case securities were kept abroad or in private vaults the bank might pay interest or dividends only upon statements under oath as to the place of deposit and the amount of the securities. The banks were to furnish this information to the Treasury. As a result of this measure securities were sold again and paper money again hoarded, or sent out of the country. So the game of "hide and seek" was played on a national scale. To prevent the flight of capital may require international cooperation for currency exports remain uncontrolled.^^ "Deutsche Allgemetne Zeitung, March 15, 1919. "Deutsche Allgemeine Zeitung, ibid., March ij, 1919; Associated Press dispatch, Weimar, July 23, 1919; Journal of Commerce, September 17, 1919. "Koelnische Zeitung, November 2Z, 1919; Algemeen Handelsblad, Amsterdam, November z, 1919; Commerce Reports, November 29, X9J9. Digitized by Microsoft® GERMAN PUBLIC FINANCE 167 G. Thb Outlook But heavy taxation will not assure the financial future of Ger- many. No perspective is true which omits from view the in- demnity and the financial demands of the victorious powers. The manner of settlement of the indemnity determines the outlook in Germany. i. Further Inflation and Bankruptcy Proposed Advocates of cheap money, and those who would Cure her economic ills by printing more paper money are not lacking in Germany. Frequent proposals were made to repudiate the war loans, or to issue non-interest bearing loans which would circulate as currency, as means of ridding the state of interest charges and of balancing the budget.'^ In view of the increasing deficits in the budget, and the large indemnity that Germany is to meet, national bankruptcy is seriously being advocated as a solution. Some German bankers regard the step as inevitable in view of the loss of resources, the lack of raw material, the undernourishment of the population and the inability to obtain credit. This bankruptcy may take the form of a reduction or suspension of interest, temporarily or indefinitely,, the repudiation of the principal, or even a confiscatory tax on interest from war loans. The spirit of the people is depressed and direct taxes cannot be increased. Indirect taxes would further lower the standard of living or else compel the government to subsidize the distribution of food, causing the deficit in the budget to increase. Opposition to a declaration of bankruptcy is based on financial, social, and ethical considerations. Cessation of interest payments or cancellation of state debts are regarded as impossible proposals. The savings banks and insurance companies have billions invested in war loans. The commercial banks are holding billions of short- term indebtedness, almost 50 billion on March 31, 1 920. Public announcement of insolvency would reduce the taxable income in Germany by an amount greater than the charges on the debt. Furthermore, the expedient would be "unjust, brutal and anti- "A typical example is a pamphlet by a Dr. Alexis Schleimes, "Muit We Pay Interest on War Loans?" See also Plutus, March 27, 1918. Digitized by Microsoft® 1 68 INTERNATIONAL FINANCE AND ITS REORGANIZATION quated" according to Dr. Walther Rathenau. It would penalize those citizens who helped to finance the war and would break the promises of the old as well as the new government of Germany. Finally, the war bonds were distributed widely among the masses who have a stake in the maintenance of the existing order. A declaration of national bankruptcy would cause the vanishing of their continually depreciating savings and might be the removal of the last prop of the social order. Because of its social results national bankruptcy is perilous.'* ii. Increasing the National Revenue The more hopeful economists expect that Germany will solve her difficulties by increasing the national income and the tax revenues. The control of national expenditures in the attempt to balance the budget was entrusted to a National Finance Commis- sioner, a new functionary, with wide powers to curtail expenditures. The extent to which drastic direct taxes have been put into eflEect has been shown. Germany has probably exhausted both in extent and severity the possible sources of taxation. It is feared even that industry will be repressed, and exports checked by the exist- ing drastic fiscal policy. Another means of meeting the fiscal demands after the war is by increasing the national income. The attempt to diminish the consumption of the individual through a tax, not on income, but on expenditures, failed of enactment. But there is a wide- spread determination to eliminate industrial inefficiency and the wastes of the competitive system. As a result of the war, produc- tion per capita was increased through the abandonment in an industry of inefficient plants and the concentration of production in those that were well located with respect to sources of supply, labor, and markets. The standardization of product, the concen- tration of industries in a few strong hands, and elimination of competition, with government encouragement and control, are being " Germany's Solvency for the Purpose of Reparation, a memorandum, prepared by Dr. Moritz Bonn and submitted by the German delegation at the Spa Conference in July, 1920. Reprinted in the New York Nation, October 6, 1920, pp. 384-390. Warburg, Max M., Die notwendigen Vorbedingungen fur die Gesundung der deutschen Wahrung, Hamburg: Ackerman and Wolf xmo* pp. 46-28. ' ' Weltwirtschaftszeitung, December 13, 1918. Digitized by Microsoft® GERMAN PUBLIC FINANCE 169 introduced in the industries either through the formation of syndi- cates of private firms or through the partial nationalization of industries. Trading in commodities, particularly those produced abroad or entering into foreign trade, will be relatively unrestricted. It is the hope that the national income will be increased by these means, so that the burden of the new budgets may be diminished.^' iii. Germany's Losses The terms of the treaty have cut down Germany's capacity '0 pay the indemnity. The loss of territory has reduced the area of agricultural production by 13.5 per cent. The inability to obtain fertilizers during the war, the decline in fodder imports and the consequent decline in live stock, resulted in a decline in the production of vegetable food of 40 per cent and in animal food of 60 per cent. Furthermore, Germany lost from 70 to 75 per cent of her iron-ore resources and will retain only 60 per cent of her capacity for producing iron and steel. The amount of steel exports available for the payment of reparation will be reduced further by the need to pay for imported ore and for meeting the minimum domestic requirements of industry. The loss of coal resources, allowing for the varying fuel value of different grades, will reduce the production to 57 per cent of the pre-war output. The seizure of German assets abroad, the rupture of foreign con- nections of German merchants and the loss of merchant shipping have eliminated a large source of invisible credits in the balance of trade. These losses have reduced industrial production to 50 per cent of its pre-war capacity. To these difficulties are added the chaotic financial condition, the lag between wages and rising prices, and the psychological depression. There are slight offsets to these losses. Apparently Germany is politically stable. It has successfully weathered a revolution with notably little cost. Bolshevism will probably find no place among a population which is lowest in illiteracy in Europe. Although, in common with labor in other countries, German labor is weary and discontented, an adequate supply of food would probably restore the habits of industry and thrift that prevailed "Prof. Franz Eulenburg, Germany's Financial Policy After the War. Welthandel, June 21, 1918. Walther Rathenau, Die Neue Wirtschaft, a book devoted to the subject. George Munch, in the Vossische Zeitung, January ao, 1918. Digitized by Microsoft® 170 INTERNATIONAL FINANCE AND ITS REORGANIZATION before the war. Widespread vocational training and technical skill, the fruits of the pre-war period, are still assets of the Ger- man workers, even though they may lack the raw material to which to apply them. iv. Prerequisites for Payment of Indemnity The reparation demands will call for 34 per cent of the cur- rent annual output of Germany's coal production, and 40 per cent of the building capacity of the German shipyards before the war. In addition to these annual charges, a lump sum of 132 billion gold marks was finally accepted by Gfermany as the indemnity. Assum- ing that an indemnity of only 50 billion gold marks, the definitely fixed minimum, is to be levied, the interest at 5 per cent and sinking-fund at i per cent will require 3 billion gold marks or 30 billion paper marks. Can Germany pay this sum? In order of precedence, reparation payments must come after the population has had food and employment, and after the deprivation of goods during the war has in part been made good. To provide these two needs, prior to reparation, Germany needs credit. For example, the raw material necessary in the textile trade requires credit of 4.5 billion gold marks. Before these additional credits can be obtained outstanding credits must be paid. In the 14 months from January, 191 9, through February, 1920, the excess of imports over exports, plus the unpaid balance of imports from neutral countries during the war, totaled mk. 60 million, of which about ID billion have been paid through the exportation of gold and securities. Germany can pay only in goods — ^by an excess of exports over imports. For even if she mortgaged all the private and public property in Germany, she could pay interest to her creditors only in commodities. The charges of interest and amortization on 132 billion gold marks would absorb the entire pre-war national savings of Germany and would leave Germany without any surplus capital for the inevitable new developments that are the marks of a progressive civilization. Heavy taxation will remove the incentive to effort and production. Since Germany can pay the indemnity only by exports, the Allies must decide whether they wish to restore the prestige of Germany. They are by no means unanimous in this decision for at least one of them feels, that a prosperous Digitized by Microsoft® GERMAN PUBLIC FINANCE 17I Gennany means a powerful and vengeance-seeking enemy. If Germany is put in a position where she can have an excess of exports, she may be able to pay a part of the indemnity. Other- wise the hope of her liquidating the indemnity is largely futile. In order that she may be restored, her finances must be put upon a sound basis. The amount of her liabilities under the reparation clauses will determine the volume of the floating debt and will determine also whether her budget will balance. For, if only the 50 billion gold marks definitely fixed in the treaty were set as the total indemnity, the per capita debt would be about i thousand gold marks or about lo thousand paper marks. The average head of a family of four would at 6 per cent have to pay annually 2400 paper marks for interest and sinking fund. According to the statistics of Prussia in 1918, 81 per cent of the taxpayers had an income of less than 3 thousand marks. And taxpayers are a rninority of the population. A strict execution of the treaty of peace would lead to national bankruptcy in Germany. The extent to which the German people will prefer the evils of high taxation to the evils of national bankruptcy depends on the Allies. Germany will not recover for a number of decades at best. The rate of her recovery will determine not only the rate of repara- tion payments but also the rate of the restoration of Europe and even of the world at large. The world may not yet be a political unit but it undoubtedly has long been an economic unit. Rather it is an economic organism, which cannot flourish while a part of it is restricted or ceases to function. Germany's progress from 1871 to 1914 is an earnest of what she may achieve in the coming half century, not only for herself but for her former enemies. For the prosperity of both France and Great Britain before 1914 was promoted by the activities of their thriving neighbor. Whether Germany's prosperity will mean a renewal of military rivalries is for her republican regime to determine. But the lesson that in modern warfare, even the victors lose, is not likely soon to be forgotten.'* " Memorandum of the German Delegation, id. Alfred Lansburgh, in Die Bank, June, 1919. Dr. Carl Melchior, Frankfurter Zeitung, Dec 30, 1919. Digitized by Microsoft® Digitized by Microsoft® Part Two CURRENCY AND CREDIT CHAPTER V PRINCIPLES AND PRACTICE IN THE WORLD WAR A. Inflation and the Central Banks ^ i. How Inflation is Produced When war loans are subscribed for, out of the savings of the public, inflation does not result. Wheri subscriptions are made out of loans at the banks, inflation is producedi In the former case, the banks merely transfer the credit from the public to the government. The subscribers receive bonds. The government in turn exchanges the credit for goods and services rendered. The recipients, munitions makers and others, return this credit to the banks. This procedure does not involve any increase of deposits. Moreover the munitions makers, themselves or through their employees and sub-contractors, may subscribe for bonds and repeat the cycle described. The repetition of this operation makes it pos- sible for such large amounts of loans to be raised. However, when the banks themselves make advances to their customers to enable them to subscribe, credit is created. Similarly if the banks borrow from or rediscount at the central bank, using war paper as col- lateral, additional credit is created. But credit is created by means other than subscriptions out of bank loans. During the late war the central banks of Europe made direct advances to their governments, when receipts from loans and from taxation were inadequate to meet expenses. The government gave the bank its securities, which became a bank ' First Interim Report of the Committee on Currency and Foreign Exchanges After the War (Cd. 9182), 1918, p. 4. Address of Sir Edward H. Holden to the stockholders of The London City and Midland Bank, Supplement to the Statist, January 27, 1917. 173 Digitized by Microsoft® 174 INTEENATIONAL FINANCE AND ITS REORGANIZATION debit or asset, and in return the government increased its deposits, which were credits or liabilities on the books of the bank. As^ the government drew on its account to pay for war goods and war services, the credit, government deposits, was transferred to private deposits. The above procedures constitute two methods of making fiat credit. Inflation may be brought about through the issue also of fiat currency. In England the government itself issued currency notes, which were made legal tender but were inadequately backed by gold. The French government created fiat currency by a less direct process. It called upon the Bank of France for notes, which were issued against government securities. In Germany currency was manufactured not only by the government — Reichskassen- scheine — but also bv the war credit institutions which were estab- lished. ii. Peace Conditions vs. War Conditions . In normal times the inflation of credit is held in check by regulations which enable bankers to supply gold upon demand of depositors or noteholders. As credit expands, prices rise and with them the demand for legal tender currency, needed to conduct the increased volume of trade. The central banks of issue, then raise the discount rate, which has a double effect. Credit is con- tracted and prices consequently fall, for goods carried on credit are forced on the market. The decline in prices stimulates exports and checks imports and thus causes an inflow of specie. Further- more, the rise in the discount rate of the central bank attracts foreign gold. The decline in the ratio of reserve to liabilities is thus checked. The convertibility into gold of paper money and of deposit credit restricts inflation within narrow limits. During the World War, the belligerents suspended gold payment and as a result the increase of fiat money and fiat credit continued with- out check. In times of peace, newly established industries produce goods for consumption which are bought by wages paid in other industries. In times of war, munition plants produce no goods consumable by wage-earners. The stock of consumable goods remains station- ary or even declines, whereas the volume of money increases. The result is a rise in prices. In times of peace, money for new industries comes from the surplus of other industries. In times Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 175 of war, money for new industries conies from taxation, or enforced saving, from loans, or voluntary savings diverted from industrial expansion, and from inflation, or stealing by the state. At the beginning of the war subscriptions to loans represent genuine transfer of control over goods and services from private hands to the government. The assets turned in represent real wealth. Toward the end of the w^ar subscriptions for bonds are made out of borrowings or in the depreciated currency or credit. The sub- scriptions represent not real wealth but merely a share in the future goods and services of the nation. In times of peace the interest on an industrial bond represents genuine income, a portion of the surplus of industry. But in times of war the interest on a government loan does not represent a portion of a surplus, for the expenditures exceed the income of the nation.^ B. Government Bank Statements i. Changes in Statements of Banks of Neutral and Belligerent States A comparison of the statements of the banks before the war and after the war shows that the post-war holdings of specie were 1.80 times the pre-war holdings. Deposits rose to 4.53 times the pre-war figure. The notes of the central banks increased to 9.45 times the pre-war amount or if we include the paper money issued by the governments themselves, to 16.53 times. The fact that deposits and notes rose so much more in volume than gold and silver of the Central banks is one of the evidences of inflation. The liabilities of the banks increased more than their real assets, gold and commercial paper. The huge volume of government promises to pay watered the assets. The ratio of gold and silver to notes and deposits of the central banks declined from 60.1 per cent before the war to 13.8 per cent after the war. These are the indicators of world-wide inflation, for the Allies, the Central Powers, and the neutrals on the several continents were all affected. However, the problem cannot correctly be presented as a world problem. The countries were not equally affected and each country must be studied in the light of the causes and manner of inflation within it. The solutions will also be different for the several groups. 'Lansburgh, A., Die grossen Notenbanken in Dienste der Kriegfuhren- den Staaten; p. 212. Die Bank, July, 1915, pp. 499-512. Digitized by Microsoft® 176 INTERNATIONAL FINANCE AND ITS REORGANIZATION The neutrals and inactive belligerents show some inflation of their metallic holdings, but their note circulation and deposits did not increase to a much greater extent than did their specie holdings. There was little currency inflation and credit inflation was not considerably greater than gold inflation. In the neutral countries listed the metallic holdings increased to 2.13 times the pre-war holdings, the deposits to 3.28 times, the circulation of the notes of the central banks alone to 2.93 times, and the circulation of the notes of both the central banks and of the government to 2.43 times pre-war figures. The fairly proportionate increase in specie and in note and deposit liabilities is indicated by the fact that the ratio declined only from 57.7 to 49.0 per cent. Some of the neutral countries, realizing that the inflation of prices was due to an increase in the gold holdings of the central banks, restricted the importation of gold. The belligerents listed show a lesser increase in the gold and silver holdings than the neutrals, a greater increase in deposits, and a vastly greater increase in the note circulation of the central banks. If government issues are included the increase in notes becomes more disproportionate compared with the increase of gold. The holdings of gold and silver of the central banks rose 1.75 times, the deposits 4.59 times, the notes of the central banks 11.28 times, and the total note issue, including government notes, 19.76 times. The considerable margin between the increase in note and deposit liabilities and the increase in metallic holdings indicated inflation of credit and of currency. The ratio of specie to note knd deposit liabilities in the banks declined from 61.2 per cent before the war to 11.9 per cent after the war. If the belligerents are grouped, the banks of the Allied Powers show less inflation than those of the Central Powers. In the former case the gold holdings increased to- 2.01 times the pre- war amount, the deposits to 3.39 times, the bank notes to 7.30 times, and all notes, including government issues, to 17.58 times. The ratio of metallic holdings to note and deposit liabilities declined from 62.0 per cent to 21.2 per cent. The banks of the Central Powers present the poorest show- ing. The deposits increased to 10.85 times the amount before the war, the notes to ,25.74 times, and if government issues are included to 28.86 times. On the other hand the specie holdings after the war were only 0.49 times the pre-war amounts. As a result the ratio of gold and silver holdings to the sum of note and deposit Digitized by Microsoft® PRINCIPLES AND PRACTICE IN TfiE WORLD WAR 177 liabilities declined from 57.5 per cent to 1.3 per cent. The decrease in the gold holdings was due to the exportation of gold to neutral countries during the war when the credit of the Central Powers was exhausted, and after the signing of the armistice to the surrender of gold, under the treaty, for the purchase of food, and to the theft by Roumania. ii. Changes in the Items on Bank Statements The specie holdings for all the countries listed increased to 1.80 times the pre-war amount; those of the neutrals and inactive belligerents, however, increased to 2.13 times and those of the belligerents to 1.75 times pre-war holdings. During the war gold moved from the belligerents to the neutrals. The holdings of the Allies increased to 2.01 times the amount before the war but the holdings of the Central Powers after the war were only 0.49 as great as before the war. The specie holdings of Roumania increased most, for the reason mentioned above, and those of Italy actually decreased. The relative increases ranged in the following order: Roumania, Greece, Japan, Great Britain, United States, Russia, Portugal, France, Finland, Belgium, and Italy. Turkey was the only one of the Central Powers which increased its metallic hold- ings (2.19 times). Austria-Hungary had only 0.19 times the gold holdings after the war that it had before the war. The increase in the gold holdings of the neutrals and the inactive belligerents varied less than that of any of the groups, if we exclude Brazil. Those of the Netherlands increased to 3.82 times pre-war holdings. The other countries, in the order of increase, were Switzerland, Denmark, Norway, Spain, Sweden, down to Argentina (2.03 times). The deposits of the central banks of all the countries listed increased to 4.53 times the total deposits before the war But those of the neutrals and inactive belligerents increased to only 3.28 times. Naturally, among the belligerents there was greater infla- tion than among the neutrals. The deposits in the banks of the belligerent countries increased, to 4.59 times, in the banks of the Allies to 3.39 times, and in the banks of the Central Powers to 10.85 times pre-war figures. Within the group of Allied Powers the deposits of the bank of Roumania, increased most (83.00 times). The- deposits of the bank of France increased least (2.38 times), because payment by check had not developed in France to any great extent. The countries Digitized by Microsoft® 178 INTERNATIONAL FINANCE AND ITS REORGANIZATION arranged in order of the increase of deposits are: Rbumania, Belgium, Japan, Greece, Portugal, Italy, Finland, Russia, Great Britain, United States, and France. Within the Central Powers, the increase of deposits was as follows: Austria-Hungary 22.00 times pre-war amounts; Germany, 12.30 times; Bulgaria, 4.37 times; and Turkey, 1.14 times. The notes of the central banks of issue in all the countries listed increased to 9.45 times pre-war figures, but in the neutral countries to only 2.93 times. The note circulation in the bel- ligerent countries was increased to 11:28 times the amount before the war, that of the Allied countries to 7.30 times and that of the Central Powers to 25.74 times. Note inflation was least among the neutrals and greatest among the Central Powers. Within the group of the Allies, the note circulation was increased most in Russia and least in Japan. The countries were ranged in the following order: Russia, Roumania, Finland, United States, Italy, Greece, France, Portugal, Belgium, Great Britain, and Japan. Within the Central Powers, the note circula- tion of Austria-Hungary increased to 28.20 times the pre-war circulation, in Germany to 27.36 times, in Bulgaria to 16.10 times, and in Turkey to 2.40 times. The increase in note circulation in the neutral countries and the inactive belligerents did not vary as widely as in the other groups and ranged from 3.42 times the circulation before the war in Norway down to 1.69 times in Argentina. The addition of the notes issued by the governments them- selves to those put out by the central banks brought about a greater inflation than the above figures show. The increase for all the countries was 16.53 times pre-war amounts but only 2.43 times in the neutral countries. The total note circulation in the bel- ligerent countries after the war was 19.76 times the amount before the war, in the Allied countries 17.58 times, and in the Central Powers 28.86 times. The inclusion of government paper money changes the position of Great Britain from tenth to third in the order of the Allied Powers and Belgium from ninth to fifth. On the other hand the United States put out practically no government paper during the war, and its position declined from fourth to ninth in the series. Among the Allied Powers Russia is first on the list with the largest increase in the total notes issued, and Japan last. The countries are ranged in the following order: Russia, Roumania, Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 179 Great Britain, Finland, Belgium, Italy, Greece, France, United States, Portugal, and Japan. Among the Central Powers the issue of paper by the banks was so great that even if we include the government issues the increases are not greatly changed, except for Turkey. The same applies to the neutrals and inactive bel- ligerents. Tables of pre-war and post-war figures of specie, deposits and note issues of certain central banks are given herewith: Tabi£ of Pke-Wak and Post-War Specie and Deposits op Important Banks op Issue' (in million dollars) Pre-war date (4) Post-war date Specie Holdings Deposits Country (a) Pre- war (i) Post- war (e) Ratio Pre- war te) Post- war (A) Ratio United States Great Britain France Mar. 30, 1917 July 29,1914 July 30, 1914 July 31, 1914 July 8,1914 Aug. 1, 1914 July 30, 1914 Mar. 13, 1914 Mar. 29, 1914 Mar. 31, 1914 Mar. 31, 1914 July 16, 1920 Ju& 14,1920 Jub^ IS, 1920 Feb. 10, 1920 Oct. 16,1917 May 15, 1920 June 24,1920 May 13,1920 May 1, 1920 May s, 1920 June 15,1920 947 186 920 288 937 109 61 45 il 7 2119 598 1126 223 1948 1i 294 293 29 8 2.24 3-22 1. 25 l.U 4.21 1.13 6.54 7-15 1. 61 1.14 707 327 257 41 566 76 24 45 1 5 1,687 872 611 152 1,779 756 391 aS6 41 S 41 17 If. 2.38 3.70 3.14 9-55 16.30 5.69 83.00 5.12 3.40 Italy... Russia Roumania Portugal FinlanH Total Allied Powers . . 3559 402 3" 25 7166 260 46 10 2,01 0.6s 0.19 2.19 0.40 2061 225 59 70 44 6,977 2,756 1,29s 80 192 3.39 12.30 22.00 1.14 4-37 Centkai. Poweks Germany Austra-Hungary. July 23,1914 JuV 30, 1914 Dec. 31, 1913 Mar. 31, 1914 June 23, 1920 Mar. 7,1920 Dec. 31, 1918 Feb. 29,1920 Bulgaria Total Central 760 4319 224 125 21 68 14 246 29 38 374 7S40 455 11 261 40 593 70 120 0.49 1-75 2.03 0.25 2.90 3.82 2.86 2.41 2.41 3.l6 398 2459 2 4 18 10 4,323 11,300 10 S8 38 224 74 23 10 85 Total belliger- ents 4.S9 Brazil) Argentina Brazil Mar. 31, 1914 Mar. 31, 1914 July 31, 1914 July 25,1914 July 31,1914 JiUy 24,1914 July 25,1914 July 23,1914 May 26 1920 May 31, 1920 May 31, 1920 June 28, 1920 June 15, 1920 June 26, 1920 June 26, 1920 June 23, 1920 Denmark Netherlands 39.00 9.50 Spain 2.43 4.11 Switzerland 2.30 Total neutrals. 76s 5084 1631 9171 2.13 1.80 130 2589 427 11,727 3.28 Grand total of J Based on Gottlieb's figures in American Economic Review, Sept, 1920, giving original sources. Digitized by Microsoft® l8o INTERNATIONAL FINANCE AND ITS KEOEGANIZATION Table op Pkb-Wak and Post-War CntcuiATioN or Notes of Iufoktakt Banks of Issue and of their Goveenuents (in million dollars) Countiy Bank Notes in Ciiculation Ratio of Specie to Note and Deiposit Liabilities Pre- war (a) Post- war (W Ratio fr) Pre- war Post- war (e) '&>tal Bank and Government Notes in Circulation Pre- war (0 Post- war (i) Ratio W AUIZD FOWESS United States. . Great Britain . France Italy Russia Japan Belgium Greece Roumania Portugal Finland 357 MS 1290 421 84a 163 316 44 84 90 33 3,136 60s 7,asa 2.974 9,457 590 997 368 875 433 334 8.80 4-17 5.62 7.10 11.90 3.56 4.63 6.08 10.43 4.82 10.18 89.0 '39-4 59-5 62.3 66.5 45. 6 35. 4 50.6 46.1 18.4 35.0 43-9 •40-5 14. 3 71 17.3 34.1 5.0 S6.l 22.7 6.1 3-2 71S 223 1290 518 843 163 316 +4 84 90 23 4,017 3,6x6 7,253 3,593 50,156 730 2,059 368 2,608 433 234 5.63 "•73 5. 62 6.94 59-57 4-4» 953 6.09 31 OS 4.81 10.17 Total Allied Powers. . . CEHtKM. Powers Germany Austria-Hungary . Turkey Bulgaria 3675 450 432 5 36 36,831 13,394 13,148 12 S8i 27-35 28.20 2.40 16.10 62.0 59.6 63-5 38. o 31-3 31.2 1-7 0.4 So.o 1-3 4208 538 433 5 36 73,956 15,720 12,148 726 S8l 17-58 29.23 38.12 145-30 16.13 Total Central Powers. Total belliserents Neutrals (including Brazil) Argentina Braiil Denmark Netherlands Norway Spain Sweden Switzerland 923 4598 342 175 42 125 33 56 52 25,035 51,856 578 S68 138 404 113 747 181 171 25-74 11.28 1.69 3-2S 3-28 3-24 3.42 2.02 3.23 3.29 57-5 61. a 65. 5 71-4 so.o 53.5 37-8 52. 8 39-a 61.3 1-3 11.9 78.7 5-5 41.2 56.5 26.5 6i.i 61.9 lOZX 5319 342 175 42 135 33 370 S6 52 29,17s 103,131 578 S68 138 404 113 747 181 173 28.86 19.76 1.69 3-25 3-29 3-23 3-42 2.02 3-23 3-33 Total neutrals. Grand total of powers listed 1195 5793 2,900 54,756 9-45 57-7 60.1 49.0 13-8 1195 6414 3,903 106,033 16.53 • For the consolidated issue and banking departments. The ratio of metallic holdings to the sum of note liabilities and deposit liabilities of the central banks shows the relative infla- tion. For all the countries listed the ratio declined from 60. i per cent before the war to 13.8 per cent after the war. But for the neutrals, the ratios before and after the war were 57.7 per cent and 49.0 per cent, respectively; the increase in paper currency and in deposits did not greatly exceed the increase in the gold holdings of the neutrals. The ratio for the belligerents was 61. a Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR l8l per cent before the war and 11.9 per cent after the war. But the Central Powers show a worse disorganization after the war, the ratio declining from 57.5 per cent to 1.2 per cent. For the Allied Powers the ratio of metallic holdings to note and deposit liabilities combined declined from 62.0 per cent to 21.2 per cent. C. Effects of Inflation on Prices The indices of inflation are a rise in prices, a depreciation of the rates of exchange, and a premium on metallic money. Only the first of the three effects named will be considered here. The others will be discussed under foreign exchange. The close relation existing between the inflation of credit or of currency and a rise in prices becomes evident when the increase in inflation is compared with the increase in prices. A table prepared in a White Paper of the British Board of Trade (Cd. 734 and 434) shows a close parallelism between currency expansion and price movements.* The United States experienced the least increase in currency and the least increase in wholesale and retail prices. France and Italy, on the other hand showed the greatest increases in currency and in prices. Country Latest date Currency of all kinds (1913 = 100) Wholesale prices (1913 = 100) Retail prices of food (1914=100) United States United Kingdom . . Switzerland Max., 1920 Mar., 1920 Dec, 1919 Jan., 1920 Oct., 1919 Mar., 1920 Feb., 1920 Feb., 1920 Feb., 1920 Dec, 1919 177 250 253 2SS 274 27S 290 30s 400 S6S 2530 321.8 266.'3 354- 522.4 452 -6 196 23s 237 251 Sweden 291 199 294 297 (Paris) 352 Netherlands Norway France Italy 'See also the London Economist, Nov. 29, 1919, p. 978; June 12, 19*0, p. 1288. Retail prices of food rose less than general wholesale prices in part because of the policy of price-fixing and also because of the subsidizing of food prices. In the case of the United Kingdom the circulation at the outbreak of the war, is used as a basis of comparison. Commerce Reports, July 30, 1920, reprinted a part of this report Digitized by Microsoft® l82 INTERNATIONAL FINANCE AND ITS REORGANIZATION The reader may find a similar parallelism by using the price indices and the bank statements appearing in the Federal Reserve Bulletin. The close correspondence between the increase in the currency and the rise in prices in various countries can be traced by a com- parison of international price fluctuations before the war and dur- ing the war. Prof. Wesley C. Mitchell showed that the general course of wholesale price fluctuations in the United States, Eng- land, France, and Germany was, broadly speaking, similar in the 21 years, 1 890-1 910. The index numbers for these four countries all decline in the middle of the nineties to the lowest point in the period, all rise in the later nineties, all fall at some time between 1900 and 1904, all rise sharply to a new maximum in 1907, all drop in 1908, and all rise once more between 1908 and 1910. During the 21 years the extreme differences in prices in the four countries were as follows:** Between prices in- England and America France and America Germany and America England and France England and Germany France and Germany Points Year 10 1903 6 1901 7 1902 S 1900 6 1900 8 1910 A point is l/ioo of a price index number based on the average price levels of 1890-1899 and taken as 100. This close correspondence between prices irt the United States and in the three countries of Europe does not hold for the period of the war. The differences become far greater. The extent of the variation in prices corresponds with the degree of inflation. Using the medians of relative prices of identical lists of commodities, 150 in the British comparison, 44 in the French comparison and 30 in the German comparison, Prof. Mitchell prepared average prices for "■ Mitchell, Wesley C, International Price Comparisons. Washington: Government Printing Omce, 1919, pp. 13, 17, 18, 89 and 43. See also his Index Numbers of Wholesale Prices in the United States and Foreign Countries. Washington: Government Printing Office, 191 5. Fart III, Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 183 Digitized by Microsoft® 1 84 INTERNATIONAL FINANCE AND ITS REORGANIZATION Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR I8S ^5 5 ^§ c^l§ S^^BiiK — Nvr — wr — vvr — ■wr — wr 2> Digitized by Microsoft® l86 INTERNATIONAL FINANCE AND ITS REORGANIZATION the years 191 3 to 191 8. A condensed summary of his tables follows: Comparative Index NtJMBEES op Wholesale Prices Countries 1913 I9I4 191S 1916 1917 1918 United States 1 01 lOI TOO 100 108 128 148 171 202 214 208 Great Britain 242 Difference lOI lOI 100 100 20 102 119 23 134 170 r2 176 226 34 United States 201 268 lOI 102 100 103 17 103 137 36 SO 67 United States Germany Difference I 3 34 Great Britain shows the least deviation from American prices, France shows a considerably greater deviation. For the year 19 15 Germany shows the greatest deviation. Later figures for Germany were not compiled. The explanation of the spread in prices is that France resorted to fiat credit to a greater extent than England, and Germany produced a veritable flood of credit by means of legislation at the outbreak of the war. The table of the British Board of Trade as well as that of Prof. Mitchell corroborates the theory that the expansion of the currency and the rise in prices closely parallel each other. The International Financial Conference at Brussels held in September, 1920, published figures showing the percentage of changes in prices and in note issues. Evidence of the close paral- lelism between the increase of notes issued and the increase of prices is afforded by the table showing these increases for the years 19 14 to 1919. The United States shows the smallest increase in both prices and note issues and Italy shows the largest increase. Price increases lagged behind note increases except in the United States, where deposit banking has developed and payment by check is more common than in the other countries listed. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 187 Relative Prices and Note Issues " (1913 figures=ioo) United States Canada Japan Sweden France Italy Year Prices Note issues Prices Note issues Prices Note issues Prices Note issues Prices Note Issues Prices Note issues 1914 1915 1916 1917 igi8 1919 100 101 "I 196 214 1 01 109 124 151 IS7 172 106 118 ID 211 236 118 136 ISS 206 239 251 9; 108 131 166 289 90 101 141 I9S 256 296 116 in 244 339 330 131 149 190 360 329 116 2o5 3S8 429 117 233 292 391 S30 652 101 170 234 36s 437 457 129 181 227 366 499 667 "Table C, p. 9, Paper III, Currency Statistics, International Financial Conference, London: Harrison & Sons, 1920, 1915 1916 1917 I9M 1919 1920 1921 Figure IV Wholesale Commodity Prices in Four Countries Average Prices in 1913 =^ 100 Per Cent Digitized by Microsoft® X88 INTERNATIONAL FINANCE AND ITS REORGANIZATION D. Prospects and Remedies The subject of reorganization of the finances of Europe will be treated separately, but a brief survey will be given here. {.The Prospect The new countries of Europe are following the methods of faulty finance which the established nations pursued during the war. Poland, hardly a year old, has a national debt of mk. 130,000 million and a budget deficit of mk. 40,000 million. The post-war period will be marked by the same developments as those which followed the Civil War and the Napoleonic Wars, when specula- tion was rife and people expected prices to remain at a high level, but deflation continued with only slight interruptions until the pre-war levels were reached. The outlook is as different for the several countries as their methods of war finance. Those countries which did not resort to very extensive inflation will probably be able to resume specie pay- ment after a relatively brief interval, following the example of Great Britain after the Napoleonic Wars and the United States after the Civil War. At the other extreme are the countries that relied almost exclusively on fiat credit and on fiat currency, for whom the sole relief will be some drastic measure such as a capital levy, a forced loan, revaluation of the currency, or even repudia- tion. Austrian krone notes were used as labels on beer bottles in Zurich, Switzerland, in 1921. The countries between these two extremes may struggle along indefinitely with a paper currency, fluctuating erratically with respect to gold like that of various countries in South America. ii. Policies In the present discussion of policies, only national factors will be taken into account. International financial cooperation seems impracticable and premature. As early as August, 191 8, the out- lines of a sound post-war financial policy were presented by the Cunliffe Committee in Great Britain. This, in general, was a forerunner of later proposals in other countries, whicli are in substantial agreement with its recommendations. There is little Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORID WAR 1 89 difEerence of opinion among students of finance as to the course necessary to adopt after the war. The Cunliffe Committee pointed out the automatic operation before the war of an effective gold standard in correcting undue expansion of credit and deviation of the foreign exchange rates. As a result of government borrowing during the war and of the unlimited issue of paper currency the gold standard ceased to exist. The committee recommended that an effective gold standard be restored, otherwise there would be danger of progressive credit expansion which would jeopardize international trade relations. The prerequisites for the restoration of an effective gold standard were (a) the cessation of government borrowing and the reduction of the floating debt, (b) the raising of the discount rate of the central bank and its use to check speculative expansion of credit, and (c) the cessation of the issue of fiduciary currency. The official joint statement of five of the leading economists of Europe, submitted to the League of Nations, advocates the same policy. The inflation of credit and currency should cease. Gov- ernment expenditures must be reduced, not only for the army and navy, but also for the subsidies on particular commodities and services. The state budgets, must be made to balance and current expenses met, not out of loans, but out of income. Floating debts should be funded. The creation of new currency must cease and with it the artificially low bank rates abandoned. Of similar tenor is the Memorandum of the British Board of Trade, a survey of the economic condition of Europe after the war. "The question primarily is the concern of the several national governments, assisted where possible and necessary by international action. National solvency requires that public expenditure and re- ceipts be brought into equilibrium, and that borrowing, except for the most essential services, should cease. The maintenance of sound currency equally demands the discouragement of all influences tending to create inflation and especially government borrovv^ings. The withdrawal of much of the excessive depreciated circulating media, and the limitation of future issues is equally one of the, primary duties of the newly established government. Until this is achieved stable conditions cannot be realized."" •Board of Trade Journal, June 3, 1920, contains an abstract of this report. Digitized by Microsoft® igo INTERNATIONAL FINANCE AND ITS REORGANIZATION (a) Credit and Currency Before and During the War — Before the war, the volume of note circulation and of deposit liabilities was restricted by the maintenance of a specific relation between these liabilities and the gold reserves of the banks of issue, A rise in the discount rate caused the contraction of loans, and therefore of deposits, and simultaneously it increased the gold re- serve by attracting foreign funds. The Bank of France regulated the gold supply not so much by changing the rate of discount as by charging a premium on gold to be exported.' A lowering of the discount rate stimulated enterprise, increased loans and de- posits, and facilitated the export of gold. During the war the principle of limiting note and deposit liabili- ties by means of the gold reserve was abandoned. Gold payments were suspended directly or indirectly, practically everywhere. High discount rates were no longer needed to protect gold reserves. Low interest rates were established to facilitate the financial operations of belligerent governments. The free movement of gold before the war not only governed domestic credit and currency, but regulated the foreigri exchanges. Fluctuations did not exceed the cost of settling in gold. The results of the abandonment of the gold standard were twofold. At home inflation ensued, prices rose, and government credit was weakened. Abroad, exchange rates moved adversely. To check the evils of inflation, price fixing and rationing were introduced fairly effectively. To overcome the effect of adverse exchange in increasing the cost of imported essential goods, the belligerents sold securities accumulated before the war, raised private loans abroad, and established a preferential discount rate to attract foreign funds, and finally when these means were ex- hausted, the belligerent governments borrowed of foreign govern- ments associated with them in the war. All these measures merely postponed and really aggravated the ultimate fall of exchange rates to a level at which they conformed to the relative purchasing power of the currencies of the several countries. (b) Post-War Policies^ — There is little difference of opinion on the point that stable ' Conant, p. 65, 5th Edition. 'Warburg, Paul M., Fiscal and Currency Standards as the Future Measure of the Credit of the Nations. Address before Second Pan-Ameri- can Financial Conference, January aa, 1920. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 191 conditions can be restored only by balancing budgets and as a corol- lary ceasing to issue further government loans or additional paper money, by digesting government loans and paper held in the banks, and by restoring the free movement of gold." The free movement of gold is the last step, for gold exports from a country having huge note issues would create financial chaos. The first step toward a re-establishment of financial stability is the balancing of the budget, by increasing income or by decreasing expenditure or both. There is an intimate relation be- tween fiscal policy and financial stability. Through popular subscription provision must be made for fund- ing the floating indebtedness, and for pulverizing the large blocks of government securities held by the banks. With their portfolios gradually rid of government loans, the banks become able to place their resources at the service of trade. As government paper diminishes among the assets of the bank, the offsetting deposit credit is reduced. Either bank notes may be retired or deposits decreased. Popular loans will accomplish this result quickly. Retirement through taxation, that is, through an excess of national revenue over national expenditure, will achieve this end more slowly. Under either method eventually the balance sheets of the banks will again, as before the war, show a small per cent of assets in government securities and a large per cent in commercial paper. When this stage has been reached, the effective discount rate may be restored, gold shipments resumed, and foreign exchange stabilized. Those countries whose note circulation and deposit liabilities are greatly inflated can not follow this procedure. Many years will have to elapse before they can retire the excess of notes, either by taxation or by funding, or reduce the holdings of govern- ment securities, chiefly short-term notes against which deposit credits have been created. For these countries attempts at deflation 'An occasional dissenting opinion is registered. Walter Leaf, at a meeting of the stockholders of the London County and Westminster Bank said: "I am no believer in proposals for artificial restriction of the cur- rency. To say that the total issue of treasury notes shall not exceed an arbitrary amount seems to me useless. So long as the government is freely issuing claims for currency, it must supply the currency to meet them. To fix an upper limit would merely bring us to a point when the banks would find themselves unable to meet the demands for notes and we should have to choose between bankruptcy and a removal of the restrictions. You can't cure a fever by plugging your clinical thermometer at 'normal.'" Financier, August 11, 1920. Digitized by Microsoft® IQa rNTERNATIONAL FINANCE AND ITS REORGANIZATION Slowly must be abandoned for it is hopeless to try to restore the pre-war gold value of the monetary unit. The simplest procedure, perhaps the only course possible, is to revalue the monetary unit at approximately its current value in gold as was done in the case of the Argentine paper peso. Suggestions for stabilization of prices at their present level are futile. The free movement of gold is possible only if an inordinate amount is not required for settling trade balances. The world supply of gold was adequate for this purpose before the war when prices were at a lower level than at present. The stabilization of prices would necessitate the abandonment of gold as the governor of the machinery of international credit. No adequate substitute has ever yet been found. Some statesmen and publicists have advo- cated the maintenance of the inflated currencies until the volume of goods produced is sufficient to require the existing volume of currency. This proposal also is futile. There are varying degrees of inflation in the several countries and production cannot be in- creased in varying proportions in each of them. Again the rise in thp price level during the war was greater than the price in- creases of a century or more. Whereas sudden deflation may be "a terrible end," the proposal to stabilize prices until time overtakes them would constitute "an endless terror." In the rela- tion between goods and paper money, between commodities and tokens, the former are primary, and the latter must conform to fluctuations in production and not determine them. Theoretically, present price levels might be maintained, if a supply of gold equal to the existing supply of paper were discovered. Ftactically, stabilization is impossible. Digitized by Microsoft® CHAPTER VI BRITISH CURRENCY AND CREDIT This chapter will treat of as much of the development and organization of British banking before the war as is necessary to understand the main topics, namely, the effect of the war on British credit and currency, the legislation enacted to meet the war emergency, the changes in the statements of the Bank of England, the effects of inflation, and the post-war policy. A. The Bank of England, Development and Organization The origin of the Bank of England^ may be traced to the pro- posal in 1691 of William Paterson, a Scotchman, who offered to advance £1,000,000 to the government on the condition that it pay him £65,000 annually to cover interest and cost and that it give him authority to issue bills which should be legal tender. The act establishing "The Governor and Company of the Bank of England" was passed in 1694. The checkered history of the in- stitution will not be traced here. Until 1826 the Bank of England had a practical monopoly of all joint-stock banking in England. The act of 1826 permitted the establishment of joint-stock banks of issue beyond the radius of 65 miles from London, The act of 1833 permitted any corporation or partnership to carry on banking in London itself or within the 65-mile radius on the condition that it did not issue notes. The act of 1844 gave the Bank of England the exclusive right of note issue but permitted existing banks of issue to maintain their outstanding circulation at the same time providing for the contingency of the retirement of this circulation. In the event of such retirement the Bank of England might in- crease its note issue by an amount not in excess of two-thirds of the bank notes retired. The Bank of England, as remodeled by the act of 1844, has two separate departments, the issue department and the banking de- 'Conant, Chip, iv and v. 193 Digitized by Microsoft® 194 INTEENATIONAL FINANCE AND ITS REORGANIZATION partment. The theory of this separation is that an expansion ol note issues by private banicers had caused panics and that therefore panics may be prevented by confining the right of issue to the Bank of England and by limiting bank note issues above a fixed sum to a paper pound for every gold pound. The theory is that notes and deposits are distinct in their effect in expanding the demand liabili- ties of the bank. "The currency principle" was the basis of the separation. The bank note became merely a certificate of coin and commercial paper became the instrument of credit w^hich the bank note previously had been, under the regime of unrestricted issue by private bankers. By the act of 1844 government securities to the value of £14,- 000,000 were transferred to the issue department, as well as the gold coin and bullion held in the banking department in excess of its requirement. The issue department then turned over to the banking department the equivalent amount in notes. Thereafter, notes and coin or bullion became interchangeable at a fixed rate at the issue department. As a result of the retirement of the out- standing issues of the joint-stock banks the fiduciary circulation of the Bank of England has increased from £14,000,000 to its present level, £18,4.50,000. The weakness of the act was revealed by the crisis of 1847, when it failed to function according to the theory of its sponsors. It did not limit speculation because credit expansion was possible not only through note issues but also through deposits and loans. Speculation therefore was not prevented. Furthermore the theory that the amount of gold would fluctuate with the amount of notes likewise failed because gold was obtain- able at the bank, by the presentation not only of notes but also of checks. Indeed, the effect of the act in time of panic was to hasten the withdrawal of deposits from the joint stock banks before the gold supply could be withdrawn by the presentation of out- standing notes. At such occasions the bank act was suspended and notes issued to any desired extent without requiring a corresponding deposit of gold. The act of 1844 which restricted note issues but not deposits hastened the development of deposit banking. The Cheque Bank was established soon thereafter, received money on deposit, and issued books of checks, limited to the amount of the deposit. Another development of interest was the use of a rise in the interest rate in inducing an inflow of funds and thus main- taining an adequate gold reserve in times of stringency of credit. Digitized by Microsoft® BRITISH CUEKENCY AND CREDIT IQS English credit rests upon the gold reserve of the Bank of England because the private and joint-stock banks do not maintain a separate gold reserve. They carry as much cash as is needed to transact daily operations and carry the balance at the Bank of England. The joint-stock bank rediscounts at the Bank of England and can draw against this deposit and obtain notes, convertible into gold. The Bank of England can control the money market not only by changing the discount rate but also by borrowing in the market, that is, by selling a part of its holdings of consols for cash and buying an equal amount for future delivery for the monthly account. The excess funds of the market are thus absorbed, and the market rate for money is forced up. The consols sold are returned to the bank at the monthly settlement.^ The Bank of England is governed by 24 directors, a governor and a deputy governor who are usually senior directors. In addi- tion to its banking functions the bank acts as agent of the govern- ment, receives public deposits and acts as the banker of the state, though not as its cashier. The Bank of England is a bankers' bank. All the credit in- stitutions, the joint-stock banks, the discount houses, the bill brokers, and the acceptance houses rely upon it for rediscounting bills. These bills may arise out of trade with various parts of the world. In addition to commercial bills, finance bills are also drawn on London by bankers in many parts of the world. London is the world's clearing-house for foreign bills. It is a great center in the trans-shipment or re-export trade. Interest on Britain's vast foreign investments and British loans to the Continent for use in stock- exchange transactions before the war were additional factors which made London a sort of governor of the international financial ma- chinery. The British bank rate was quick to register changes in foreign financial conditions. B. War-Time Legislation and Expedients The feature of the days just before the war, in financial terms, was a decline in stocks on the exchanges in Vienna, in Berlin and then in Paris, followed by the closing of the stock exchanges in Vienna, Budapest, Brussels, Antwerp, Montreal, Toronto and Madrid by July 28. On July 29 quotations were discontinued in ' Conant, History of Modern Banks of Issue. Fifth Edition, p. 137. Digitized by Microsoft® igfi INTERNATIONAL FINANCE AND ITS REORGANIZATION Berlin, the next day the exchanges in Petrograd and in South America closed. On July 3 1 the stock exchanges of London, Paris, and New York closed. In this chaos, with collateral underlying stock-exchange loans shrinking, and with British bills on the Central Powers uncollectible, the banks retrenched, called loans and withdrew funds. i. The Moratorium On August 2, for the first time in English history, a moratorium for one month was proclaimed, and on August 3 legalized by the Postponement of Payments Act. The law covering the general moratorium reads (Ch. II, 4 and 5 Geo. 5) : "His Majesty may by proclamation authorize the postponement of the payment of any bill of exchange or of any negotiable instru- ment, or any other payment in pursuance of any contract, to such extent, for such time, and subject to such conditions as may be specified in the proclamation." By Royal Proclamation of August 6 it was directed that the moratorium should not apply to payment of wages or salary, a liability not exceeding £5, taxes, maritime freight, debt from any person, firm, company or institution outside the British Islands, dividend or interest on Trustee Act Investments, liability on bank notes, old-age pensions, or other payment to be made by the govern- ment, payments under the Insurance Act and under the Work- men's Compensation Act, or payments of deposits in savings banks.' By a series of proclamations under the moratorium act, pay- ments which were due up to September 3 were postponed to No- vember 3. This, however, did not apply to the payment of rent, or to the payment to or by a retail trader. However, under the (Emergency Powers) Act of August 31, 1914, "no person shall proceed to execution on any judgment for the recovery of a sum except after application to the court or enter into any property, realize any security, forfeit any deposit, or enforce the lapse of any insurance policy for the recovery of any sum of money except after application to the court." The court had discretion to stay execu- tion for such time as it thought fit.* 'Withers, Hartley, War and Lombard Street, pp. 133, 136, 137, 143, 14s. Readers who lack access to the British Statutes will find the 'early financial legislation of the war here, 'Withers, ibid., pp, 1(2-165. Digitized by Microsoft® BRITISH CURRENCY AND CREDIT IQ? The moratorium, stopped the machinery of finance in order to avoid bankruptcies. Remittances to London from many parts oi the world had stopped. The foreign exchanges were upset and bankers were deterred by fear from discountin,g bills. To terminate the deadlock and to enable trade and commerce to resume its normal course, the Bank of England agreed to discount any ap- proved bill of exchange accepted before August 4 without recourse to the holder and upon its maturity to assist the resumption of normal business by giving the acceptor opportunity of postponing payment, interest being payable at 2 per cent over the bank rate.^ The Bank of England agreed to provide the acceptors with funds to pay approved pre-moratorium bills at maturity, thus re- leasing the drawers' and endorsers' of such bills from their liability, except their liability for payment to the acceptors. The acceptors were to collect from their clients as soon as possible and to apply the funds to repay advances made by the Bank of England, on which the interest charged was 2 per cent above the ruling bank rate. On its part the Bank of England agreed not to claim repay- ment of any amount not recovered by the acceptors from their clients for a period of one year after the close of the war. Until the end of this period the Bank of England's claim was to rank after claims on post-moratorium transactions. In order to facilitate new business, the joint-stock banks arranged, with the co-operation of the Bank of England and the government, to advance to clients the amounts necessary to pay their acceptances at maturity where the fimds had not been provided in due time by the clients of the acceptors.' The government guaranteed the Bank against any future losses that it might incur under this arrangement by agreeing to charge them against the public debt. ii. Suspension of the Bank Act The financial disturbance caused a withdrawal of funds. De- positors, however, received only 10 per cent in gold and 90 per cent in the notes of the bank. However, these notes were con- vertible into gold at the issue department, and as there was no bank ' Notice pubJished on August 13, 1914, concerning tlie discounting of bills by the Bank of England. • From a Statement of -the Treasury, September j, 1914.. Digitized by Microsoft® ig8 INTERNATIONAt FINANCE AND ITS REORGANIZATION note under £5 note holders besieged the issue department and de- manded gold coin. On August 6 the bank act was suspended and the bank "temporarily authorized to issue notes in excess of the limit fixed by law"; the bank was discharged from any liability in connection therewith. iii. Issue of Currency Notes The unlimited issue of notes of the Bank of England, par- ticularly had small denominations been provided for, would have satisfied the demand for notes. This course was adopted in France, and with the exception of a small increase in the Reichskassen- scheine it was also the course adopted in Germany. The issuing banks in both cases merely increased the supply of notes, but the government issued none. England went one step further. On August 6, 1914, the Currency and Bank Note Act was passed. This authorized the Treasury itself to issue currency notes for £1 and for los. which would be legal tender in any amount. To meet the immediate exigencies, postal money orders were made legal tender up to any amount. Legally and theoretically, the holder of a currency note might "obtain on demand during oflSce hours at the Bank of England payment for the note at its face value in gold coin." This, of course, was not the practice. Cur- rency notes were issued through the Bank of England to bankers to a maximum limit of 20 per cent of their liabilities on deposit and current accounts. The amount issued was treated as an advance by the Treasury and bore interest at the ruling bank rate. The bank might repay, at will, notes advanced. The amount advanced was a floating charge on the assets of the bank. The banks might obtain certificates or book credit with the Bank of England in lieu of and on the same terms as actual currency notes. A re- demption account for the notes was opened consisting partly of coin and bullion, Bank of England notes fully covered by gold, and government balance at the Bank of England, but chiefly of government securities. C. The Bank of England During the War i. The Bank Statement and the Currency Situation The statements of the Bank of England during the war furnish, in conjunction with the currency note account, a picture of the Digitized by Microsoft® BRITISH CURRENCY AND CREDIT 199 growth of inflation. A brief discussion of the form of the state- ment of the Bank of England will be helpful in understanding the changes during the war. Staieuent of the Bank of England as of Septembek 15, xgao (in thousand pounds sterling) Issue Department Assets Liabilities Government debt n,ois 7,435 i2i,SS8 Note issue. 140,008 Gold coin and bullion .... Total 140,008 140,008 fiatio of gold to notes issued Banking Department 86.6% Government securities . . . 56.103 83,391 14,843 , 1,536 Proprietors' capital Rest (surplus) . . 1 14,553 3,529 15,202 122,589 Notes Gold and silver coin Other deposits and bills. . . Total 155,873 155,873 Ratio of gold and notes to liabilities n -9% The Bank of England gives 11,9 per cent as its ratio of re- serve to liabilities. This applies to the banking department only and is the ratio of the notes and gold in the banking department to the sum of its liabilities, public and other deposits and bills. In the issue department, the ratio of gold coin and bullion to notes issued is 86.6 per cent. If now, the issue and banking departments are consolidated and if the notes held as assets in the banking department are subtracted from the total note liabilities in the issue department so as to get the net liability on notes in circula- tion, the ratio of total gold and silver to total note and deposit liabilities is 46.8 per cent.^ ' Unaware of this fact, some American business men chided the Federal Reserve Board for raising the discount rate, and for its inability to operate on lower rates, with a reserve in excess of 40 per cent, when the Bank of England was operating on a reserve, they thought, of 12 per cent. Digitized by Microsoft® 200 INTERNATIONA!, FINANCE AND ITS REORGANIZATION slateuemt 07 isstte and banking departments coitbinxo a8 01 Sefteubek 15, 1930 (in thousand pounds iterling) Gold 123.093 18,450 56,103 83,391 Proprietors' capital Rest (surplus) 14,553 Securities for uncovered 3.529 125.165 137,790 Government securities — Other securities Notes in circulation Deposits and bills Total Total 281,037 281,037 Ratio of gold to combined deposit and note liabilities 46.8% Although the above presents a true statement of condition of the Bank of England, it takes no account of the very large amount of currency notes outstanding, which have contributed to inflation as much as if they had been issued by the bank instead of by the government. The currency note account is offset chiefly by govern- ment securities and to a small extent by gold and Bank of England notes. CuBKENCY Note Account as of September 15, 1920 (in thousand poimds sterling) Gold 28,500 18,650 : 323,975 ISO Notes outstanding Reserve accoimt 354,416 16,859 Bank of England notes. . . Government securities — Balance at the Bank of Total Total 371.27s 371,27s Ratio of the sura of gold and Bank of England notes to currency notes outstanding 13 .3% To get a true picture of the condition of the currency in Great Britain it is necessary to merge the currency note account of the Treasury with the consolidated statement of the two departments of the Bank of England. Digitized by Microsoft® BEIXrSH CURRENCY AND CREDIT 201 Statement of the Bank of England (Isstm and Banking Departments) AND Cdkrency Note Account of the Treasury Merged as of September 15, 1920 (in thousand pounds sterling) Gold 151,593 18,450 380,078 83,391 Proprietors' capital Surplus and reserve a/c. . . Bank of England notes, and currency notes Deposits 1 1 14,553 2Di388 460,931 137.640 Securities for uncovered Govenunent securities Other securities Total Total 633,512 633,512 Ratio of gold to combined note and deposit liabilities 25 . 3% The merged statement of the currency note account and of thf combined departments of the Bank of England is now comparable to the statement of the Bank of France, in which country the gov- ernment issued no paper money but relied upon the bank of issue for additional amounts of notes. ii. Changes in the Bank of England Statement The statements of the Bank of England during the war present clearly the changes in the holdings of gold and of government securities and in the note and deposit liabilities. Statement of the Bank of England ' Issue and Banking Departments Combined (in million pounds) Items Dec. 31. 1913 July 29. 1914 Dec. 30, 1914 Dec. 29. 191S Dec. 27, 1916 Dec. 26, 1917 Dec. 35, 1918 Dec. 31. 1919 Dec. 29, 1920 Assets 3S 18 13 S2 38 18 II 48 70 18 IS 106 S2 18 33 112 S4 18 57 107 59 18 S8 95 79 18 71 93 91 18 93 107 128 6<>yeniment securities: Hdd by issue dep't.... Held' tor baakingdep't.. 18 108 86 Total 119 IS 3 10 61 30 lis IS 3 13 54 30 209 IS i 36 21S IS 3 SO 112 3S 236 15 3 52 127 39 230 IS 3 42 124 46 261 IS 3 24 149 70 309 IS 3 19 i8e 91 340 LUBIUIIES Roprietors' capital IS 3 14 175 Notes in cixculation 133 Total 119 100 too 100 100 100 "S 109 84 ^g 100 209 2C30 IIS 270 210 120 2IS 148 2S4 SOO 184 117 236 155 438 S20 208 130 230 168 446 420 204 IS3 261 226' 546 240 244 233 309 260 716 190 297 303 340 166 government securities in banking department. . . 832 T40 Other deposits 287 Notes in circulation 443 " Weekly returns in London Economist and of Bank of England. Digitized by Microsoft® 302 INTESNATIONAX FINANCE AND ITS REORGANIZATION Digitized by Microsoft® BEITISH CURRENCY AND CREDIT 203 18 2 ? A Digitized by Microsoft® 204 INTERNATIONAL FINANCE AND ITS REORGANIZATION The amounts in sterling and the relative figures, using the 1913 returns as 100, show an increase in gold in the beginning of the war, and a decline during 1915 and 1916, intermittently, as a re- sult of gold exports to pay for purchases in foreign countries. After the United States entered the war the Bank of England's gold holdings increased, for British purchases were financed not by British gold but by United States government credits. After the armistice the gold holdings increased very greatly because the seas were again safe for the unhindered shipment of the precious metals from the mines. Government securities rose relatively more rapidly than any item on the balance sheet, declining intermittently after the issue of long-term loans which refunded short-term securities as well as ways and means advances and reaching a high point in 1920. The item, "other deposits" rose as public deposits were reduced and distributed through payment by the government of the claims of private companies and persons. Notes in circulation rose practically continuously following the outbreak of the war. The changes in the condition of the Bank of England are also reflected in the ratio of the various items to the total assets or liabilities. Before the war government securities constituted a very small percentage of the total assets but they increased rela- tively as government finance displaced the demands of trade. On the other hand, the item "other securities" was the largest asset item in the bank before the war. As a percentage of the total assets it rose, because of the bills discounted without recourse by the Bank of England, but declined thereafter and in both 1919 and 1920 represented a smaller percentage of the total assets than gold. Gold declined from about 33 per cent of the total assets before the war both because of large gold exports during 191 5 and 1916 and because of the more rapid increase of other asset items. The lowest ratio of reserves in the banking department was 7.30 per cent on December 30, 1920. After the United States entered the war, and particularly after the armistice, gold became a more im- portant asset and in June, 1920, was the largest of all. Percentage of Total Assets of Certain Items at Bates SPECirna) Items Dec, 31. 1913 July 29, 1914 Dec. 30, 1914 Dec. 29, 191S Dec. a?. 1916 Dec. 96, 1917 Dec. igiS Dec. 31. 1919 Dec. a9. 1920 29.4 11. 1 «.9 33.1 9.6 41. 1 33. a 7-1 SO. 9 n.o IS. 3 Sa.a 33.0 24.« 4S.0 as. 4 as. 4 41.3 30.3 87.2 35. 4 a9.4 So.i 34.6 37.7 81.8 »s.s Governmeht securities in banking depai^tmcnt Digitized by Microsoft® BRITISH CURRENCY AND CREDIT 20S A table showing the changes in the three important items in the balance sheet of the bank at intei'vals of four months is given herewith. Gold, Notes and Secueittes of the Bank of England (in million pounds sterling) [Source: London Economist weekly returns; also Federal Reserve Bulletin, Dec, 191 7, Oct., 1918, May, 1920] Date Gold and silver in issue and banking dep'ts Bank of England notes in circulation Total securities in banking department 1914 Tulv 20 38.0 52.9 69-5 53-9 52.2 61. s 51-5 56.7 61.4 53.6 54-3 54-0 57-5 55-1 58.3 60.6 65.2 71.5 79-1 843 87.8 88.2 91-3 112. 2 117. 9 123.1 128.3 29.7 35-0 36.1 35-2 34.6 32.8 35-3 33-6 35-9 36.5 39-7 38.3 39-4 41.2 45-9 47.8 53-7 60. s 70.3 73-6 78.3 81.6 91-3 105-3 120.1 127-5 132-8 58-3 141.6 Sept. ^0 Dec. 30 1915 Mar. 31 184.6 204.0 163.6 144.9 Sept. 29 Dec. 29 1916 Mar. 29 129.5 137.6 163.6 163.6 145-5 151.8 153-2 168.3 152.5 154-5 163.2 136.4 147-6 109.9 199.2 129.9 193-3 131. 2 193-9 Sept. 27 Dec. 27 1917 Mar. 28 Tune 27 Sept. 26 Dec. 26 1918 June 26 Sept. 21; Dec. 25. . 1919 Mar. 26 Tune 21; Dec. 31 1920 Sept. 20 The continuous issue by the government itself of paper money with very slight security was a potent cause of inflation. The currency note issue was backed by £28^500,000 gold in June, 1915. This amount has remained constant since, but the amount of notes outstanding has increased eightfold since and as a result the ratio of gold in the redemption account to currency notes outstanding Digitized by Microsoft® 206 INTERNATIONAL FINANCE AND ITS REORGANIZATION has declined from a high record of 69.1 per cent in March of 1915 to a low record of 8.3 per cent in June, 1919. Since the latter date the Bank of England notes have been placed in the redemption account in increasing amounts. As these notes are covered by gold to the extent of about 85 per cent they are the equivalent of gold cover for the currency note. CuEHENCY Note Redemption Account (in million pounds sterling) [Source: London Econombt] Notes Bank of Ratio Govern- Balance outstand- Coin and England ':-% ment at bank Date ing bullion notes securities of England (a) (6) w W) W tf) 1914 Aug. 25 31. S 11.4 Sept. 30 28.4 4-5 is'.'s 10.9 9.1 Dec. 30 38.S 18.S 48.1 9-9 9-3 191S Mar. 31 39-8 27-S 69.1 8.6 35 June 30 46.6 28.5 61.3 9-6 8-7 Sept. 29 72.0 28.S 39-S 20.4 23.0 Dec. 29 103. 1 28.5 27.6 S4-6 20. s 1916 Mar. 29 106.7 28.5 26.6 71. 1 7-9 June 28 122. 1 28. 5 234 88.2 7.0 Sept. 27 131 S 28.5 21.6 99-3 6.0 Dec. 27 150.1 28.S 19.0 118. 1 6.9 1917 Mar. 28 144-7 28.5 19.7 no. 7 6.9 June 27 161. 7 28.5 17.6 132. 5 S-6 Sept. 26 178.6 28. s 16.0 153- S-2 Dec. 26 212.8 28.S 13-4 186.6 SS 1918 Mar. 27 228.1 28. 5 12.5 202.9 5-8 June 26 252.9 28.S 11.3 229.8 S-3 Sept. 25 275.2 28.5 10.4 253 -I S-i Dec. 31 1919 Mar. 26 323- 2 28.5 8.9 30s -I 4.6 328.1 28. 5 8.7 308.6 5-4 June 2S 342.3 28.5 8.3 327.3 3-3 Oct. I 33S-0 28.5 1-3 8.9 317s 3-6 Dec. 31 356.1 28. S 4.0 9-1 337 S 2.8 1920* Mar. 31 333-4 28. s S-9 10. 313-4 3.0 June 30 357-4 28. 5 13-4 II. 7 331 -7 0.3 Sept. 29 353 -8t 367-6? 28.5 18.7 133 332.4 0.4 Dec. 29 28.S 19s 13-0 336 -5 0.1 'Maximum fiduciary iasue for 1920 fixed at £320,600,300. flncludes notes called in but not yet canceled. Digitized by Microsoft® BRITISH CURRENCY AND CREDIT 207 British Currency Notes snd Cert/f /cafes. Compared wrtfi Total Deposits and Nate Circulation of the Bonk of Lng/ond OJmt.3 ofXipoOjOOO) Currency notes ehe/ cert/fi^gfes Bonis of£nglamt total deposits Sank cf England note dfculation 115 7 / ; ^. FiGims VII D. Effects of Inflation The increase of deposits in the banking department of the Bank of England and the issue of currenqr notes inevitably led to in- flation. Evidences were not lacking. Prices rose, wage increases followed. Gold bullion sold at a premium in London, and the balance sheets of the joint-stock banks swelled. 1. Increase of Prices The Economist index number of commodity prices increased more than threefold. The peak of prices was reached in March, 1920, and prices declined very rapidly after that date. Digitized by Microsoft® 2o8 INTERNATIONAL FINANCE AND ITS REORGANIZATION Date Economist index niunber Percentage Average 1901-5 2200 100. July, 1914 December, 1914 2565 116. 6 2800 127.3 December, 1918 6094 277.0 December, 1919 7364 334-7 March, 1920 8352 379-6 October, 1920 717s 326.1 December, 1920 5924 269.3 The Statist-Sauerbeck index number showed likewise a prac- tically continuous rise in prices until the spring of 1920 and a marked decline thereafter. Date Statist index number Average, 1818-27 III 1873 III Average, 1880-99 66 Average, 1906-15 82 June, 1914 81.2 December, 1914 91.6 December, 1918 196.0 December, 1919 235-2 April, 1920 266.1 October, 1920 239-9 December, 1920 207.8 The index number of the British Board of Trade showed similar results. The fact that these three British index numbers are based on different commodities explains the slight discrepancies in the relative change between any given dates. The Price Section of the War Industries Board prepared tables of relative prices of identical lists of 150 commodities in the United States and Great Britain. They show a rise in both countries. The United States index lagged behind the British, and as a result of price fixing in the United States did not increase much during 1917 and 1918. Digitized by Microsoft® BRITISH CUKEENCY AND CREDIT 209 Medians of Relative Pmces of Identical Lists of 150 Commodities, in Great Britain and m United States " (Average prices in year ending June, 1914 = 100 ) 1913 I9I4 191S I9I6 19x7 19x8 Period Eng. U.S. Eng. U.S. Eng. U.S. Eng. U.S. Eng. U.S. Eng. U.S Year, total First quarter Second quarter. . Third quarter. . . Fourth quarter. . lOI XOI 101 XOI 100 lox lol 100 xox 100 100 100 99 99 103 100 99 99 100 100 128 112 I2S 140 108 100 103 III 117 171 IS8 170 169 186 148 133 14s 147 16S 214 201 212 213 228 202 x88 206 207 242 239 241 242 246 208 209 207 207 209 ii. Increase of Wages As prices rose wages followed. In some industries, notably in the manufacture of textiles, wage increases were based largely on increases in the cost of living. In the cotton industry at the end of February, 1920, wages were about 2.05 times the pre-war level although wage hours had been reduced about 13 per cent. In the wool industry wages increased about 2.25 times. In the building trades about 2.06 times for bricklayers and 2.6i times for common laborers. In the engineering and shipbuilding trades, the wages of iron moulders and shipwrights rose to 2.05 times the pre-war wage, and of unskilled labor to 2.80 times. Wages in agriculture rose to about 2.30 times pre-war figures. Clerical salaries about doubled. iii. Premium on Gold In view of the fact that during the war gold was not used in domestic trade in Great Britain, inflation cpuld not be measured by the discount on paper or the premium on gold, as it was measured in the United States after the Civil War. In foreign trade, however. Great Britain has from time to time permitted the exportation of gold. In maintaining her supply of gold. Great Britain has had to bid for newly mined gold in the international market against the Far East, South America, and the United •Mitchell, ihid., p. 18. Digitized by Microsoft® 210 INTERNATIONAL FINANCE AND ITS REORGANIZATION States. The premium on gold is reflected in the price of gold in sterling paper. At mint parity 85 shillings buy i ounce of gold. The paper price of gold has gone over 100 shillings per ounce, and has fluctuated with the rate of dollar exchange.^" iv. Increase in Accounts of Private Banks As a result of the policy in financing the war, British Gov- ernment securities became an increasingly important asset of the joint-stock banks. In the consolidated pre-war balance sheet for the five leading banks, the London Joint City and Midland Bank, the London County Westminster and Parr's Bank, Lloyd's Bank, Barclay & Co., and the National Provincial and Union Bank of England, British Government securities constituted about 6 per cent of the total assets on June 30, 1914, whereas on June 30, 1920, they constituted about 16 per cent. On the latter date, the item British Government securities was 7.55 times as large as in the pre-war balance sheet. The increase was practically continuous. The offsetting liability, deposits and current accounts also increased, but to a less extent. Among the assets, bills of exchange declined during the war, but rose from 1918 onward. The increase of this item in the 191 5 balance sheet probably resulted from the moratorium, and the subsequent decrease resulted from the re- striction of commerce on other than government account. Cash in hand, which includes currency notes and credits at the Bank of England, increased after 1914, and by 1920 had risen to 3.10 times the pre-war figure. In brief, government borrowings caused the manufacture of credit, and the issue of currency notes in- creased the cash of the joint-stock banks. The paid-in capital and surplus increased as a result of large profits during the period of inflation, but deposits increased more rapidly. The volume of business done per unit of capital increased from 1914 to 1920. ^ On December 3, 1919, London quoted a price of to6 shillings an ounce, a premium of 19 shillings, or 22 per cent, which likewise measures the premium on New York exchange in London. On December 16, 1920, the London rate for gold was 117s. 6d. and for New York sight bills $3,50, a premium of 39 per cent on gold and New York bills or a discount of 28 per cent on paper and on London bills. Digitized by Microsoft® BRITISH CURRENCY AND CREDIT 2:1 Pbincipal Items op Balance Sheet of Leading Joint Stock Banes" (in million pounds) [Dates are for June 30 of each year] Assets Cash in hand and with Bank of England . . British Government securities Bills of exchange Advances Total assets (including items omitted) LlABILTnES Capital Reserve Current deposit and other a/c Rexative Figuses Cash in hand and with bank Government securities Bills of exchange Advances Total assets Current deposits and other a/c 191S 1916 1918 1919 1920 86 38 6s 28S j6s 95 89 303 146 187 S6 303 149 182 50 359 198 196 173 357 28s 251 181 516 632 28 19 554 100 100 100 100 100 100 778 706 195 254 137 lOS 123 127 827 30 174 497 86 105 131 133 876 176 484 77 125 139 143 1 107 30 23 1018 234 521 269 124 174 184 1639 41 38 1505 335 667 279 179 255 273 363 284 158 820 1761 57 45 1585 310 7SS 244 285 27S 2S6 E. Post-War Policy In January, 191 8, the Treasury and the Minister of Recon- struction appointed a committee "to consider the various problems which will arise in connection with currency and the foreign ex- changes during the period of reconstruction and to report upon the steps required to bring about the restoration of normal conditions in due course." In his address to the stockholders of the London City and Midland Bank at the end of January, 1918, Sir Edward Holden recommended the consideration of the question of the repeal of the Act of 1844 in order to prevent a repetition of the breaking down of the Act, and the issue of currency notes to take the place of bank notes. Apparently at this suggestion, the Committee on Currency and Foreign Exchanges was subsequently authorized "to consider the working of the Bank Act of 1844 and the constitution and functions of the Bank of England with a view to recommend- " Based on returns of the banks, and on the London Economist. See Federal Reserve Bulletin, October, 1920, p. 1044, and April, 1920, p. 374. For methods of increasing cash reserves and the influence of the war loan see Industry and Finance, A. W. Kirkaldy, pp. zzo, 223, 226, 230. Digitized by Microsoft® 212 INTERNATIONAL FINANCE AND ITS REORGANIZATION ing any alterations which may appear to them to be necessary or desirable." " i. Efficacy of Bank Act Before the War The committee report points out how the Bank Act of 1844 maintained an effective gold standard before the war. When ex- change was favorable, gold would be imported, and legal tender bank notes outstanding would be increased to meet the demands 6i trade. As prices rose, exports would decline and imports increase. As exchange became adverse, gold would be exported and the ratio of reserves to liabilities of the Bank of England reduced. If it became necessary to remedy the situation, the bank would raise the rate of discount and would thus retain gold within the country and might even attract gold from other countries. Simultaneously credit would be restricted, goods carried on borrowed funds forced on the market, and prices depressed. As a result imports would be checked, exports stimulated and the adverse trade balance cor- rected. Gold would again flow into the country, thus completing the cycle. This automatic machinery adjusted British trade and prices to world conditions. ii. The Breakdown of the Bank Act During the War As explained in detail above, the Bank Act was suspended, at the outbreak of the war, bank notes were no longer convertible into gold upon demand, and the unlimited issue of currency notes was authorized. Therefore the extent of the depreciation of paper was not determinable, in domestic transactions at least. Theoret- ically the currency note remains convertible into gold. But gold exports to correct the exchanges, if permitted, would soon exhaust the gold reserve. The depreciation of the exchanges is due to the creation of deposit credit against huge volumes of government securities, and against commercial bills of importers in the finan- cially weak countries of Europe, which cannot be liquidated within the usual trade term. Under conditions of depredated paper and inconvertibility into gold the international position of London in " First Interim Report of the Committee on Currency and Foreign Ex- changes After the War, August, 1918. Final Report, December, 1919, and Treasury Minute. H. M. Stationery Office, 191$, 1919. Reprinted in British Board o£ Trade Journal and Federal Reserve Bulletin. Digitized by Microsoft® BRITISH CURRENCY AND CREDIT 213 trade and finance is jeopardized. The restoration of an effective gold standard is essential. iii. The Prerequisites for the Restoration of the Gold Standard Credit may be deflated by funding the floating debt through popular subscription, by limiting public expenditures, and by in- creasing production. The liquidation of bank loans will reduce the offsetting deposits. The reduction of government securities held by the banks and their absorption by the public, by payments against their deposit accounts will have a similar effect. The pay- ment of taxes (by checks) will reduce aggregate deposits and will make it possible to reduce or cancel the government short-term debt." (a) Cessation of Government Borrowing — Ways and means advances, or borrowings by the government from the Bank of England, were authorized by Parliament and in- tended to be a means of providing funds not for long periods, but for temporary needs, to anticipate assured revenue or contemplated permanent borrowing. The government must not only cease to borrow further through Ways and Means advances, but it must repay those outstanding, either by taxation or by means of public subscription to long-term government loans. Drummond Fraser has proposed the use of continuous day-to-day borrowing, or the sale of bonds by the same methods as war saving certificates, as he holds that the need for reducing not only ways and means ad- vances, but also the floating and maturing debt puts too great a strain on the taxable capacity of the country. Whether loans or taxes be resorted to, payment by check will reduce the credit balance of the depositor and thus the aggregate deposit of the joint-stock banks and their balance at the Bank of England. The Bank of England deposits will be decreased when the government securities it holds are retired. (b) The Utilization of the Discount Rate — During the war interest rates were kept low to facilitate gov- ernment financing. To attract foreign funds while a low rate "Address of H. A. Gibson, before the Economic Section of the British Association, August 26, 1920. Digitized by Microsoft® 214 INTERNATIONAL FINANCE AND ITS REORGANIZATION prevailed, a differential rate was established in their favor. The Bank of England paid a higher rate on its foreign funds borrowed than it received on its funds loaned at home. The bank rate changes during the war were as follows: Bank Rate Changes " Date of change 1914 January 8 January 22 January 29 July 30 July 31 August I August 6 August 8 1916 July 13 1917 January 18 April s 1919 November 6 1920 April IS 1921 April 28 Rate per cent Duration in da)^ 4i 4 3 4 8 14 7 182 I 10 6 5 I S 2 6 70s si s 189 77 6 94S 7 161 6i 378 On June 19, 1917, the bank paid 4 per cent on deposits at three days' notice, of clearing-house banks, and on February 14, 1918, reduced the rate to 3 per cent. However, on deposits made with it by joint-stock banks of money representing foreign balances on deposit with the latter, the Bank of England maintained a rate of 4j^ per cent from November 15, 1917, until August 29, 1919. The rate paid by the joint-stock banks on deposits is ij4 per cent below the discount rate of the Bank of England, In Novem- ber, 1919, the discount rate of the Bank of England was raised from 5 per cent to 6 per cent, and on April 15, 1920, the rate was further raised from 6 per cent to 7 per cent. The aim was to deflate credit and to reduce prices as well as to improve the exchange position of sterling, in view of the fact that Belgian and other bank rates had advanced. There are two schools of bankers, who "Kirkaldy, Industry and Finance, p. 215; also Stock Exchange Official Intelligence, 1919, p. 1745, and London Economist at above dates. Digitized by Microsoft® BRITISH CURRENCY AND CREDIT 21 S take opposite views on the raise of the rate. One group holds that the embargo on gold exportation makes an increase in the discount rate unnecessary. These bankers regard the needs of industry for funds as a primary consideration and favor the existing embargo on gold exports, the removal of the restrictions on the issue of capital for domestic enterprise, and the maintenance of a lov/ bank rate. They hold that the raising of the bank rate retards industrial recovery, that deflation does not lower prices, and that prices will fall when production exceeds consumption or supply exceeds demand. The other bankers favor a high rate and advocate the removal of restrictions on gold exports. They hold that the raising of the bank rate to lO per cent, if necessary, would check gold exports, speculation, and the production of nonessential goods, restrict capital to enterprises for whose output there is a demand, force the sale of goods bought on credit, and thus compel deflation and the reduction of the price level. This group also advocates a high rate on government borrowing to discourage government expendi- ture, treasury bills having enjoyed a preferential rate J^ per cent under the bank rate. The division of opinion rests on the question of the advisability of slow or rapid deflation, of a mild or drastic means to restore an effective discount rate.^® (c) Limitation of the Fiduciary Issue — The Committee on Currency and Foreign Exchange recom- mends that the issue of fiduciary currency be limited and that the arrangements be terminated under which deposits at the Bank of England may be exchanged for legal tender currency without affect- ing the reserve ratio. It also suggests that the note issue should be entirely in the hands of the Bank of England. In the final report the committee recommends that the actual maximum fiduciary circula- tion in any year should become the legal maximum of the following year. A treasury minute gives effect to this recommendation by directing the Bank of England to restrict the issue of currency notes during 1920 to £320,600,000, except against gold or Bank of England notes. The committee further recommends that there "Bank Letter of Samuel Montague & Co., April 3, 1920, London Economist, April 5, 1920. Report of H. G. Grady, U. S. Trade Com- missioner at London, dated May 5, 1919, printed in Commerce Reports, June 6, 1919. Digitized by Microsoft® 2l6 INTERNATIONAL FINANCE AND ITS REOKGANIZATION should not be any early resumption of the internal circulation of gold coin, that the gold reserves now held by the banks should be centralized and transferred to the Bank of England, and that a normal minimum of £150 million should be accumulated as a cen- tral gold reserve. Until such a reserve has been built up and main- tained Mrith a satisfactory foreign exchange position for at least a year the government should reduce the uncovered note issues. When the latter has been reduced to an amount consistent with the maintenance of a central gold reserve of £150 million, the out- standing currency notes should be retired and replaced by Bank of England notes of similar low denomination. However, until such a point has been reached, the committee does not recommend the transfer of the currency note issue to the Bank of England, but prefers that it remain a government issue. Should any new notes be required they should be issued not against government securities, as was the case during the war, but against Bank of England notes, which are of too large a denomination for general circula- tion. If Bank of England notes are used as cover for additional currency notes, the demands for new currency would then fall in a normal way on the banking department of the Bank of England and afiEect again, as before the war, the ratio of reserves to liabilities. iv. Maintenance of the Bank Charter Act of 1844 Criticism of the Act of 1844 dates back to three years after its enactment when the first of the panics which it was to have prevented occurred. The Act was intended to do three things ( I ) to curtail the issue of notes by private bankers and the joint- stock banks, (2) to limit the issue of notes by the Bank of England, (3) to check speculation. Until 1826, the Bank of England was the only joint-stock bank. Many of the joint-stock banks estab- lished later had a doubtful reputation in contrast to the private bankers, whose notes, issued without legal restrictions as to cover or total amount, were fully accepted by the local public having personal knowledge of the banker. Speculation through the overissue of notes caused runs on the banks and failures. Sir Robert Peel expected that the Bank Act would cure this evil, and that above a certain fixed limit, dependent upon the amount of notes then outstanding and necessary, notes would be issued only against gold cover. He expected that as gold Digitized by Microsoft® BRITISH CURRENCY AND CREDIT 217 was paid out for notes, confidence would be restored. At the time the Act was passed deposit banking was not extensive and inflation then existing had been the result of the overissue of notes. Since then, credit banking has developed, and subsequently a point that Peel had overlooked has become quite evident, namely, that deposits were likewise payable in gold and credit inflation might result in a stringency. The issue of notes bears no relation to the demand of business — ^to the amount of commercial bills. Under the Act, if gold is not deposited in the issue department notes cannot be had, no matter how much they are needed. An extra- ordinary demand for bank notes in times of expanding business falls on the reserves in the banking department, the depletion of which precipitates a crisis. Such crises did occur in 1847, 1857, 1866, 1878 and subse- quently. In the three years first mentioned the Act was broken and notes issued without limit. Royal Commissions twice investi- gated the failure of the Act but no positive recommendation was adopted. The only remedy was the toleration of the suspension of the Act. Viscount Goschen in 1891 advocated a plan to issue notes upon reserve consisting of four-fifths gold and one-fifth securities, and to withdraw gold from the public into the reserves of the bank, and proposed at the same time that the bank be authorized in times of emergency to issue additional notes against securities upon the payment of a rate of interest sufficiently high to retire the excess circulation when it was no longer needed. The Reichsbank operates on this principle, which was incorporated in our Federal Reserve System.^* Sir Edward Holden in his address to the stockholders of the London City and Midland Bank in 1918 " discussed the weakness of the Bank Act, and made a number of recommendations. These were strongly endorsed by a committee on Banking, Currency and Foreign Exchange of the London Chamber of Commerce, which in 1 91 9 dissented from the report of the official committee appointed by the Treasury. Sir Edward Holden recommended that the two departments, issue and banking, be consolidated; that notes be issued not against gold but against both gold and bills of exchange so that the note issue might fluctuate with the demands of trade; that the note issue bear a fixed relation to gold or the cash balance ; " Conant, 5th Edition, pp. I34-13S' " Printed as a Supplement to the Statist, February a, 1918. Digitized by Microsoft® 2l8 INTERNATIONAL FINANCE AND ITS REORGANIZATION that the fixed ratio of gold to notes be lowered when necessary on the payment of a tax; and that the notes should not exceed three times the gold or cash balance. Many bankers in England believe that if these recommendations, which are substantially the principles on which the central banks of issue of other countries are based, had been in effect before the war, the declaration of the moratorium in 19x4 would have been unnecessary. Nevertheless the Treasury Committee on Currency and Foreign Exchanges recommended that the separation of the issue and banking departments of the Bank of England should be maintained, and that there should be a fixed fiduciary issue, beyond which notes should be issued only in exchange for gold. In its final report, the Committee repeated its recommendation and added that it had considered the principles governing the banking system of the prin- cipal foreign countries and was satisfied that they were not so well adapted to the needs of England as the Act of 1844. Undoubtedly the defense of the Act by the Committee is the weakest and most vulnerable part of its report. Digitized by Microsoft® CHAPTER VIII FRENCH CURRENCY AND CREDIT A. The History of French Banking i. Development of the Bank of France In order better to understand the effect of the war on French credit and currency it will be helpful to review briefly the develop- ment and organization of the Bank of France. The success of the Bank of England led to the establishment of the Caisse de Com- merce d'Escompte du Commerce on March 24, 1776, under the historic ministry of Tiurgot, but as a result of the vicissitudes of the French Revolution the bank lost its standing and was suppressed on August 24, 1793, by decree of the National Convention.^ On January 18, i8oo, Napoleon created the Bank of France, a bank of issue and of discount, with a capital of fr. 30 million. Three years later the bank was endowed with the exclusive right of note issue and the establishment of additional banks in the departments of France was prohibited. The fall of Napoleon was followed by the creation of banks throughout the several departments with the right to issue notes, and aiming to meet local needs. They were officered by local bankers. These banks grew in number, particularly in the fourth decade of the century, and served local industries in a way in which the B^nk of France did not, for it was regarded as a bankers' bank, a bank of rediscount. The details 'For collateral reading, see in addition to sources ^ven under the chapter on French Public Finance — Bank of France Reports, Banque de France, _ Compte Rendu, As- semble Generale des Actionnaires, 1914-1920. Paris: Paul Dupont. Supplement to Commerce Reports, 7B, Reports of Consul General A. M. Tbackara, September 20, 1920. Also Conant, History of Modern Banks of Issue. Laughlin, Credit of the Nations. Anderson, Effects of War on Money, Credit and Banking in France. Bogart, Direct and Indirect Costs of the World War. ' Conant, Courtois, Macleod and others. 219 Digitized by Microsoft® 220 INTERNATIONAL FINANCE AND ITS REORGANIZATION of the struggle between the local banks and the Bank of France, which wished to establish branches in the departments, are of interest chiefly in connection with the peculiar and undesirable centralization of banking in France before the World War. In 1848 an ofKcial decree provided for the fusion of the banks in the several departments with the Bank of France, and gave it the exclusive right to issue notes. This provision resulted from the lack of interchangeability of the note issues of the banks in the several departments and from the absence of clearing arrangements such as existed in other countries for the return of notes to the issuing bank. The total circulation of the Bank of France was made equivalent to the sum of the issues of the banks fused with it. The bank charter was renewed several times under conditions imposed by the government, such as the requirement of the estab- lishment of branches within fixed periods of time in all the depart- ments of France. The last charter was renewed on December 20, 1918, and the bank's privilege to issue notes was extended for 25 years from January i, 1921, subject to greater participation by the government in profits of the bank and to provisions for the retirement of the excessive note issues. The new charter also provides for progressive taxes on the circulation and for the pay- ment by the bank to the government of any excess dividend above 24 per cent. Both these funds are to be applied to the industrial rehabilitation of the country. History affords a precedent for the activities of the Bank of France during the World War. During the Franco- Prussian War the bank suspended specie payment and issued inconvertible notes which were made legal tender. The bank made advances to the government of fr. 50 million, secured by treasury bills, and total advances during the war amounting to fr. 1470 million. ii. Organization and Functions of the Bank of France (a) Ownership and Control — The Bank of France is privately owned but is controlled by the government. Since 1806 the state has had the right to appoint the governor and two deputy governors, who are subject to removal by the Minister of Finance. The general control is vested in the governing board of the bank, which consists of 15 regents and three auditors. Its members are elected at a general meeting of Digitized by Microsoft® FRENCH CURRENCY AND CREDIT 221 the Stockholders, but three of the 15 regents must be selected from among the disbursing agents of the Treasury and five regents and the three auditors must be chosen from among the stockholders. Only 200 stockholders, those holding the largest number of shares, are permitted to participate in the annual meetings. A full state- ment of the operations is furnished by the bank to the government every six months and a weekly balance sheet is published in the Journal Officiel every Friday. The governor and the deputy governor are responsible for the important measures taken by the bank, such as changes in the discount rate. The bank receives public monies on deposit and performs every public service free of charge, such as paying coupons on the public debt and issuing new loans. However, the bank does not act as an agent of the state. It is primarily a bank of issue. Its notes outstanding represent the largest part of its liabilities. The redis- counts are relatively small. (b) Rate of Discount — Because, unlike the Bank of England, It was not before the war so extensively a bank for trade, its discount rate was less sensi- tive to changes in international conditions. The French bank rate changed fewer times than did the English. The reasons are not far to seek. Primarily the large gold reserve and the reluctance of the Bank of France to part with its gold made it unnecessary to change the rate of discount to influence the gold supply. The Bank of England operated on a smaller gold basis, and permitted the free flow of gold in and out, and therefore had to rely more heavily upon a sensitive bank rate to regulate its gold supply and business conditions in general. The Bank of France experienced to a less degree the fluctuating demands of foreign trade or the effects of the rediscounts of the joint-stock banks. Again, the English banks had larger deposits, whereas the French banks have a relatively larger note circulation. The Bank of England had a lower gold reserve and was strictly limited in its power to issue notes. The Bank of France had very large gold reserves and had unlimited power of note issue. Furthermore, the British relied exclusively upon the discount rate to regulate their gold supply, whereas the Bank of France preferred to buy gold at a loss rather than to increase the discount rate. Again, as the French discount rate rose the government received a progressively increasing share Digitized by Microsoft® 222 INTEENATIONAL FINANCE AND ITS REORGANIZATION of the profits, and therefore it was to the interest of the bank to keep a low rate of discount.' The bank might issue notes only against cash or legal loans and discounts, so that every note was covered either by cash or assets. (c) Private Banks — Corresponding to the joint-stock banks of England the French private banks serve the needs of commerce. These discount com- mercial bills and accept bills drawn upon them. Bills acceptable for rediscount at the Bank of France are subject to a maximum rate which is the equivalent of the official rate of the Bank of France. This covers commercial bills but not loans on securities. Advances are made against securities as collateral at a slightly higher rate than against commercial paper. The Bank of France rediscounts the paper of the private banks and therefore the latter need carry but small cash reserves. The private banks in addition do an investment business. They make advances on securities and also sell them to the public. (d) Notes vs. Deposit Credit — The Bank of France relied largely upon notes rather than upon deposits in the making of loans, because the system of payment by check and of clearing houses was not developed in France as it was in Great Britain and in the United States. However, the Bank of France also did a large business in transferring credits between individuals, similar to the Giro Verkehr in Germany. A private bank will effect these transfers between branches within a city but the services of the Bank of France are utilized for making transfers between distant points. Again, acceptances are also media of credit and to some extent lessen the reliance upon the use of notes. This reliance upon notes rather than upon deposits explains the war-time phenomena affecting the Bank o! France. (e) Foreign Investments — Several other aspects of French banking are relevant to the financial changes resulting during the war. In the United States deposits grow out of loans; a business man desiring to expand is debited with the amount of his loan and credited correspondingly ' Conant, 5th Edition, Chapter III. Digitized by Microsoft® FRENCH CXJREENCY AND CREDIT 223 with a deposit. In France deposits accumulate in the banks in excess of the demands of industry. As a result the surplus deposits seek investment and are used to a large extent in foreign fields. Another factor which led to investment abroad was the central- ization of French banking. The struggle between the local banks in the several departments and the Bank of France or the few large credit institutions finally resulted in the concentration of banking facilities. During the decade around 1840 when the decentralized departmental banks developed greatly, industry became very active. However, in the generation before the war, large funds accumulated in France were not devoted to the develop- ment of local industry; this would have required widely scattered banks, stafled by local men familiar with the local industrial needs. The centralization of funds in a few institutions made inevitable their investment in bonds of foreign countries, because of the greater ease in following the annual budget of a few governments rather than the continually changing balance sheets of many industrial companies. This financial peculiarity had grave political defects. To safeguard her funds France had to interest herself unduly in the welfare and stability of her debtors. Her financial interests were subservient to political policy. Until January i, 1921, the French treasury paid interest in default on bonds guaran- teed by the Russian Imperial Government. In igo6 and 191 1 France by threatening to withdraw her loans to Germany was able effectively to influence German military policy in Morocco. The evils of this situation have been pointed out time and again.* M. Ribot, in an address before the Chamber of Deputies on May 17, 1915, said, "A great nation does not live on interest and dividends from foreign securities. It lives on labor and industry. The extent of foreign investment is a deceptive measure of a nation's riches. Not an abundance of capital, which it can export, but a support of enterprise which develops the means of production, is the measure of a country's riches." The incentive to invest abroad was the payment of high commissions to the bankers on poor securities, issued by second-rate governments and sold to the thrifty French peasant at a low rate of interest which simulated safety. On some issues the underwriters' margin ran as high as 18 per cent. It was not unusual for the French bankers ' Herriot, Boret, Lysis, and others, cited in my "Labor and Reconstruc- tion in Europe," pp. 35-40. Digitized by Microsoft® 324 INTERNATIONAL FINANCE AND ITS REORGANIZATION to charge from ^ to lO per cent, in contrast to 2 to 3 per cent charged in New York." As we shall see in the section on foreign exchange the great bulk of French investments were in Russia, Turkey, Bulgaria, and Mexico, a group distinguished for industrial imprudence, financial ineptitude, and political instability. The outbreak of the war made it impossible to realize on these securities and to use them, as had been expected, as an emergency reserve in case of war, French credit was hurt as the result of the Balkan War and at the outbreak of the World War, the collapse of her foreign investments aggravated an already weak fiscal position resulting from an increase of expenses, a rising debt and the lack of an expansible system of direct taxation. All these factors com- bined made it inevitable that the financial reliance of France during the war should have to be on the issue of short-term loans and on the printing of paper money. B. War-time Financial Legislation i. The Moratorium * The rumors of war in the middle of 1914 led to a rapid decline in prices on the Paris Stock Exchange; in some cases a fall as much as 40 per cent. Securities became unsalable and stock exchange loans involved amounts of about 800 million francs, on both the main exchange and the curb, the Parquet and the Coulisse. The freezing of stock exchange loans made it impossible to meet maturing obligations. On July 29, 1914, the first moratorium was decreed affecting loans dated prior to August i, 1914, and maturing before August 15. Then, three days later the moratorium was extended to bank deposits which could be drawn upon only to the extent of 250 francs and of 5 per cent of the balance. Withdrawals for the payment of wages were exempted from this provision. Withdrawals of deposits from savings banks were limited to 50 francs per fortnight per depositor. On August 9, 'National Monetary Commission, Doc. 405, pp. 232 et seg, •Le Prorogation des Ech^ances, Economiste Franfais, January ti, March 29 and April 12, 1919, pp. 44-47, 396, 459. Journal Officiel, December 30, 1918, March 46 and April i, 1919. Bourbeau, Marcel, La Bourse des Valeurs de Paris Pendant la Guerre. Paris, Librairie Gjnirale de Droit et de Jurisprudence, 1921, Part I. Digitized by Microsoft® FKENCH CUERENCY AND CREDIT 225 19 1 4, an additional moratorium was declared on all negotiable instruments, checks, bills of exchange, notes and warrants, due between August i, 191 4, and September i, 19 14. Negotiable instruments drawn on the Treasury were exempt. On August 29, 1914, a moratorium was declared on obligations of the depart- ments of France and of the communes. There was a provisional moratorium on payments arising from the sale and purchase prior to August 4, of rentes, public securities and other transferable instruments, as well as the loans for carrying them forward. However, the postponed payments bore interest at the rate of 5 per cent per annum. The moratorium also covered insurance con- tracts and the installments payable under subscriptions to the 3}^ per cent loan issued before the war began. A moratorium on house rents was also granted. The moratorium was extended by periods of 30 days up to November i, by successive periods of 60 days up to May i, 1915, and thereafter by successive periods of 90 days. In January, 1915, several banks lifted the moratorium on deposits. In October, 191 5, the Bourse moratorium lapsed and settlements were effected without difficulty. The moratorium did hot apply to government contractors after December 23, 1915, and other beneficiaries of the war after September 29, 191 6. The general moratorium was lifted after December 29, 191 8, for the rest of the population, except for those mobilized or living in the devastated areas. The moratorium on payment of interest and dividends, amortization and principal of debts of the departments and communes was lifted April i, 1920.' After December i6, 1916, no postponement was permitted unless for good cause. On December 27, 1920, a decree was enacted terminating the mora- torium eighty months after July 31, 1914.* The amount of bills, matured and extended, reached a maximum of fr. 4476 million in October, 191 4, and declined continuously to about fr. 500 million in June, 1920. ' There are few students of finance who justify the wholesale use of the moratorium in France. In view of the rediscount facili- ties of the Bank of France, which its governors did not hesitate to employ freely and in further view of the right of unlimited 'Journal Officiel, February 10, 1920. •Economiste Fran^ais, January i, 1921, p. 9. Journal OfBciel, De- cember 29, 1920. Digitized by Microsoft® 226 INTERNATIONAL FINANCE AND ITS REORGANIZATION issue of banknotes, the moratorium on deposits or even on com- mercial paper cannot be defended. The moratorium was a con- fession of fear on the part of the bankers, an incentive to hoarding on the part of the public, and a damper on the prosecution of the war. The use of notes as a means of payment induced the mora- torium more than would a system of payment by checks. ii. Suspension of Specie Payment and the Issue of Legal Tender Notes As a measure to supplement the moratorium, specie payments were suspended on August 5, 1914, in conformity with the prec- edent of the Franco-Prussian War. The bank was released from its obligation to redeem its notes in specie. At the same time the irredeemable notes were made legal tender. The Bank of France was not limited in the issue of notes other than by the flexible maximum authorized by the state, and therefore was not under the necessity, like the Bank of England, of suspending its Bank Act, or like the Reichsbank, of redefining the terms, cash and commercial paper, upon which its notes were based. The closing of the stock exchange and the general moratorium made inevitable the suspension of specie payments. C. War Operations of the Bank of France i. Changes in the Statement of the Bank of France The effects of the war were clearly reflected in the changes in the several items of the Bank of France.' The total metallic reserve in France declined slowly, from fr. 4157 million at the outbreak of the war to fr. 3850 million in the middle of 1920. The total metallic reserve at home and abroad increased considerably, from fr. 4157 million at the out- break of the war to fr. 5828 million in the middle of 1920; about fr. 1950 million of gold was sent to England as security for loans. Total government securities increased phenomenally in the same period, from about fr. 418 million to fr. 30,266 million. Loans and 'Economiste Fran^ais, I9i9,_xlvii: i, pp. 206, 267, 297, and 1920, xlviti: It Pp- 393i 423, 457, 489, covering operations during iqi8 and 1919. Les Operations de la Banque de France pendant I'Ann£e, 1920, Bulletin de Stadstique et de Legislation Compar^e, Feb., 1921, pp. 232-246. Digitized by Microsoft® FRENCH CDKKENCY AND CREDIT 227 "10 into 00 o> H ■* 00 9> •O C« oeo 00 CTk tow" t^oO to^o 0> H 00 o M to 00 00 80 >nH 5to o to 000 M poo 00 at 00 to 10 to §:§ i CO "Si to ^« 00 M 88! 8oto to 10 « H to H m H I- N to 00 8882 to V) to O in H 8 : 8 : :'S to • • H cn to ^ t4 Cf to M to r^ to i-i tvoo 1000 M to "j* to M rw moo O 00 t*.*^ ^N-t* tocao ct to ^« to Mto -4- Ot at e* a\%D to o 00 m M H ^m DOOM m M OiOioOtO to H H tOH ^ O toio (o to m ■*CTi *M O to ^ N (o «o mto O -^00 H to gtOt^O • M «O00 • 0>C4tO P» ■ 00 t* • ^ ^o ^10 ■ ** to 00 u>c< tn H o to M mot N n m m tnoo ^ to 00 ^ t* t* -^oo tot^ i-T « toto p( tor* ^ 00 '^ pf m M to H M W CTlfO t* t to io O } -^ n H to f- to 4 nto ^ cTto « t^M H m H H to ^ ' •«0 HIO ■ r«t^QO • HtO Ox ' CI a* ■ C4 « into H (O M 00 *t 00 moo '^ H cocn) ^ O 00 ^ O r^ M N H ^wir- to • SB -3.8 • : -jsaSii.a ■§ ■S .1 JSS3 ■3,B IS 1° ^1 ^1- A € eS V ri S « ® 2 9 ■s&i as-iu g SB'S O fltO rt 00 g t* en .|It| !S a §■! F-ii 5 R 9 Digitized by Microsoft® 228 INTERNATIONAL FINANCE AND ITS REORGANIZATION 1^' %jomm IIJ 8 § S 5 t I~T WW m :3c' AON n> SHI/ Ml KM SIJ uir •;» ao Wi sny air , & 1 H g Digitized by Microsoft® FRENCH CURRENCY AND CREDIT ^20 Digitized by Microsoft® 230 INTERNATIONAL FINANCE AND ITS REORGANIZATION discounts, representing the needs of commerce, declined very sharply after the outbreak of the war, from fr. 2444 million to fr. 213 million toward the end of 19 14, and rose only slowly during the war, but by the middle of 1920 almost equaled the pre-war level. Bills matured and extended, the item which reflects the mora- torium, reached their highest figure in 1914 and declined con- tinuously thereafter; on December 10, 19 14, this item amounted to fr. 3637 million and on June 24, 1920, to only fr. 523 millioa Government deposits declined continuously after the outbreak of the war, but the item, "other deposits," rose and reflected the inflation. Just before the outbreak of the war "other deposits" amounted to fr. 951 million, at the end of 1914 amounted to fr. 2671 million, ranged from about fr. 2200 to fr, 2900 million during 1917, but rose considerably above these figures from 1918 to 1920. Bank notes in circulation rose continuously from about fr. 6683 million in 1914 to fr. 37,544 million in the middle of 1920. The changes in the leading items of the statement of the Bank of France may be more clearly stated if the figures are shown relatively, using 1913 returns as 100: PKiNciPAt Items of the Bank of France in Relative Figuses (Dates as given in previous table) Items 1913 ZP TJ: I9IS I9I6 1917 1918 1919 1920, June 24 Metallic reserves at home. . Metallic reserves at home 100 100 100 100 lOO 115 US 100 164 117 108 loS 17s 129 129 233 89 129 2300 393 292 86 506 391 90 139 S040 411 530 94 141 7190 S08 614 93 140 7240 633 Total government securities . 6s8 The total metallic reserve in vaults of the Bank of France rose by the end of 19 15 intermittently to 1.29 times the 191 3 level but declined by the end of 1916 to 0.89 times the 1913 level, and thereafter through 1920 did not regain the pre-war level. How- ever, the total metallic reserve at home and abroad rose fairly continuously throughout the war and in July, 1919, attained a level 1. 41 times the pre-war figure. Total government securities rose continuously. These consisted chiefly of advances to the government and to a less extent of treasury bills discounted, that Digitized by Microsoft® FRENCH CURRENCY AND CREDIT 231 IS advances to foreign governments. In relative figures, the total government securities at the end of 191 8 when hostilities ceased, if one omits the constant item, other government securities was 70 times the pre-war figure but by June 24, 1920, had risen sharply to 10 1 times the 19 13 figure. Other deposits rose inter- mittently but considerably, and by the middle of 1 920 were 6 times the pre-war level. Bank notes, on the other hand, rose continu- ously, and after the signing of the armistice were 5.30 times the pre-war figure, and by June, 1920, had risen further to 6.58 times the 1913 figure. Ratio of Principal Items to Total Assets or LiABrLinES, in Per Cent (Dates as given in previous table) Items Assets Total domestic reserves Total government securities Liabilities Other deposits Bai^ notes Ratio or Metaixic Reserve to Liabilities Ratio metallic reserve at home to notes Ratio metallic reserves nt home to notes and deposit liabilities com- bined from last statement in June of each year 1913 1914. July igi6 1917 1918 1919 1920 S7 4 8 79 73 60 54 S II 76 71 64 33 37 13 82 19 49 8S 13 61 84 16 62 7 89 69 7 89 9 70 8 87 The varying fluctuations in the principal items in the state- ment of the Bank of France have greatly altered their relative importance. For instance domestic metallic reserves constituted 57 per cent of the total assets at the end of 191 3 and declined continuously to 9 per cent of total assets in the middle of 1920. On the other hand total government securities, which at the end of 191 3 constituted only 4 per cent of the total assets, rose con- tinuously to 70 per cent by the middle of 1920. Since the Bank of France is principally a bank of issue the bank notes were always an important item before the war. At the end of 191 3 they consti- tuted 79 per cent of the total liabilities, but in the huge inflation which followed bank notes came to constitute 89 per cent of the liabilities in the middle of 19 18. The Bank of France was noted for the very high percentage of gold to notes. Before the war Digitized by Microsoft® 232 INTERNATIONAL FINANCE AND ITS REORGANIZATION this ratio was 73 per cent. Since the gold abroad is held as security for large foreign loans we may count only the metallic reserve at home, and the ratio of this figure to total notes in circulation declined to 10 per cent by the middle of 1920. Or using the usual banking terms, the ratio of metallic reserve to note and deposit liabilities combined declined from 59.9 on June a6, 1913, to 9.3 on June 24, 1920. ii. Gold Policy (a) The Pre-War Conditions — Before the war the reserve of the Bank of France was large both in comparison with the other central banks of issue and in comparison with the total notes issued. For a number of years previous to the war the bank had been increasing its gold reserves and in the year preceding the war the gold reserve had increased from fr. 3200 million on June 26, 1913, to about fr. 4000 million on July 30, 19 1 4. In addition to these fr. 4000 million there was held by the public about fr. 3000 million." The problem as it appeared to the officials of the Bank of France was not only to retain all the gold of the bank but to embargo exports of gold and to withdraw the metal from circulation. (b) The Effect of the War— Exports of gold were forbidden to everyone except the Bank. Like Germany, France inaugurated a campaign for the transfer of gold, held by the public, to the bank of issue. As a result of this propaganda the holdings of the Bank of France rose from fr. 41 41 million at the outbreak of the war to fr. 5015 million by the end of 1915. By December 18, 1916, the gold turned in by the public amounted to fr. 1948 million.^^ After the outbreak of the war the highest gold holdings were fr. 5,590,671,000, re- ported September i, 1920, and the lowest were fr. 3,907,363,000, reported May 20, 1915. To compel the surrender of gold the government passed a law demonetizing the outstanding louts d'or and the half louts and minting coints of new design which alone would be current. "Ldvy, Raphael-Georges, French Money, Banking and Finance During the Great War. Quarterly Journal of Economics, November, 1915. Anderson refers to several other estimates, p. 83. "London Economist, December 33, 1916. Digitized by Microsoft® TKENCH CUEEENCY AND CREDIT 233 Furthermore, the law prohibited the melting of these coins and the exportation of gold coin or bullion. In this way it was hoped to force into the bank such gold as had not been turned in volun- tarily during the war. Gold was exported in order to obtain credit in England and in order to correct the exchanges. At the end of 191 8 fr. 2037 million of gold was held abroad of which fr, 1955 million was in England to cover loans by the Bank of England and by the British Exchequer, to be repaid as the French obligations to England are liquidated.^^ This gold, even though held abroad, was still considered by the French as part of the reserves of the Bank of France. This procedure may be justified in view of the fact that during the year 1919 fr. 59 million in gold was returned to France upon the repayment by the French government to Great Britain of credits amounting to £7 million, or at par about fr. 176 million. However, about 520 millions sterling French treasury bills are held by the British Treasury and Bank of England. From July 30, 191 4, to December 31, 1919, the Bank of France received fr. 2505 million of gold, which came chiefly from circulation, in response to appeals to the public. During the same period the Bank of France exported fr. 1067 million of gold to pay for war supplies and to maintain its credit abroad. The net increase for the period therefore was fr. 1438 million. Never- theless, owing to the increase in notes outstanding, the ratio of metallic reserves ;i vault to notes declined from 73 per cent at the end of 1913 to to per cent in the middle of 1920. On Decem- ber 26, 1919, the Bank of France had in its vaults fr. 3600 million, which sum remained fairly constant throughout 1920. (c) An Appraisal of the French Gold Policy — The Bank of France has been criticized for its suspension of Sfscie payment in spite of the fact that its ratio of gold to notes was probably the highest in Europe before the war.^* However, th's criticism is unwarranted because the increase in the note cir- " Report of the Bank of France, 1918. Economiste Frangais, February 15, March i and 8, 1919, pp. 206-7, 267-8, 297-300. "Anderson, p. 105, and Laughlin, p. 151. For presentation of French point of view, see Guilmard, Le role de I'or dans une periode de guerre. Bulletin de la Soci^te d'Economie Politique, November 4, 1916, pp. 106- ng. Digitized by Microsoft® 234 INTERNATIONAL FINANCE AND ITS HEORGANIZATION culation was more than 6 times that of the gold in vault. The bank would have been unjustified in suspending gold payments in a commercial crisis, but the events of the war and the inevitable policy of financing the war to a considerable extent by note issues vindicate the policy of the governors of the bank. Furthermore, the French policy was precisely the same as that of the British. During the war Bank of England notes were inconvertible and the British currency notes were convertible only theoretically. Again, the Bank of France has been criticized for not export- ing gold to correct the adverse exchanges. Here again the same defense holds. The amount of gold available was utterly inade- quate to be effective. Besides, France could not follow the British policy because Great Britain controlled the South African gold mines and was able to utilize newly mined gold. Few other nations could do likewise. Finally, during the war the French regarded their gold as the last arrow in their quiver, and after,- the war expected that the resumption of specie payment would be hastened as a result of the policy of husbanding their gold supply. The utility of a large gold supply of course is lessened by the inconvertibility of paper. The value of paper money is based upon the possibility of obtaining specie. However, when the note issues increase as greatly in relation to the gold reserves as in the case of France the value of the metallic reserve is chiefly psychologi- cal. The depreciation of paper currency is an indicator of the likelihood of redemption. The larger the gold reserve the greater is that likelihood. To some extent therefore the possession of a large, though inconvertible, gold supply does help to maintain the value of depreciated paper. The gold program is merely one phase of the larger policy of financing the war. As a result of her financial unpreparedness, France could not obtain adequate revenue from taxation during the war. This condition in turn increased the difficulty of float- ing long-term loans. Therefore, France had to rely upon note issues and upon short-term treasury bills, which, rediscounted at the bank, furnished a basis for further note issues. France, how- ever, was no more delinquent than Great Britain in failing to enforce a sound economic policy, to lessen the financial burden. France, like England at the beginning of the war, adopted the policy of "business as usual" and made no attempt to control nonessential production, or to divert labor and capital into the Digitized by Microsoft® FRENCH CURRENCY AND CREDIT 23S war industries. Other means of accomplishing this purpose were sought, namely the bidding up of prices and the inflation of the currency. Had France socialized her war economy, as England and the United States did later in the war, had she restricted non- essential production by means of embargoes on imports and exports, by establishing priority in raw materials, transportation and finance, the need for issuing notes or resorting to inflation would have been greatly reduced. The delinquency of France is not distinctive, it is a matter of degree. She erred more than Great Britain and the United States, not differently. iii. Advances to the State ^® Advances by the Bank of France to the government rose rapidly, amounting to fr. 3600 million in December, 1914, to fr. 5000 million at the end of 1915, and to about fr. 17,000 million at the close of hostilities. In the year following the armistice the advances rose to fr. 25,500 million, an increase equivalent to half the amount advanced during four years of war, and the end has not yet been reached. (a) Terms of Advances — The Bank of France advances fr. 200 million to the govern- ment without interest. Upon advances up to fr. 21,000 million the bank charges 0.48 per cent interest. Upon the next fr. 3,000 million the interest charged is 0.355 per cent and above fr. 24,000 million the bank receives 3.0 per cent interest. (b) Relative Importance of Advances to the State — The bank advances amounted to fr. 25,835 million, and con- stituted 12 per cent of the total debt, fr. 215,399 million on Decem- ber 31, 19 19. The advances to the state were the largest part of the item "total government securities." At the signing of the armistice advances to the government constituted 50.3 per cent of the total assets of the bank, and in the middle of 1920 this item had increased to 60. i per cent of the total assets. These figures "Liesse, Andre, Les Avances de la Banque de France a I'Etat. Economiste Frangais, May 1, 1920, pp. 545-547- The laws authorizing an increase in the advances to the state and the simultaneous rise in the limit of banic notes issuable are given in the Journal Officiel and quoted in the Economiste Frangais, 1919-1930. Digitized by Microsoft® 236 INTERNATIONAL FINANCE AND ITS REORGANIZATION are of great significance in judging the financial prospects of France. The liquidity of the government advances, their refund- ing either quickly by loans or over a long period of years out of tax revenues, is essential to make the bank again a flexible instru- ment of private credit. (c) Advances to Foreign Governments — In addition to the advances to the French government the Bank of France also discounted treasury bills in w^hich form advances were made to foreign governments, allied to France in the war. At the end of 1915 this item amounted to fr. 630 million but increased over fivefold by the end of 1918 and sixfold by the middle of 1920, when they amounted to about fr. 3860 million. In the statement of June 24, 1920, the advances to the foreign governments constituted about 9 per cent of the total assets of the Bank of France. (d) Repayments of Government Advances — The proceeds of long-term loans floated during the war were applied repeatedly to the repayment in part of the advances of the Bank of France. For instance on November 25, 1915, the advances to the government amounted to fr. 7400 million and by December 30, 1915, were reduced to fr. 5000 million. From October 26, 191 6 to November 30, 1916, the advances declined from fr. 8600 million to fr. 6500 million. Again from August 29, 1918 to November 28, 1918, the advances declined from fr. 19,150 million to fr. 17,006 million. There were no reductions or repayments up to the spring of 1920 because in the interval between the signing of the armistice and the latter date no long-term loans were floated. During the war the total amount of advances repaid to the bank amounted to fr. 8850 million.^' (e) Advances After the Armistice — Under the financial policy pursued after the armistice France desired to avoid putting additional burdens on the taxpayers or on the investment tmarket during the transition period in order that private initiative might operate freely and thus bring about the return to normal conditions. This policy of course involved an "Report of the Bank of France, 1918. Economiste Fran5ais, May 24, X919, p. 644. Digitized by Microsoft® FRENCH CUEEENCY AND CREDIT 237 increase of advances by the bank to the state, an increase of notes and a further rise of prices. Throughout the war the manage- ment of the Bank of France urged the Treasury to avoid a resort to bank advances and note issues, but complied with the requests of the government.^^ When the proceeds of the November, 1918, loan were exhausted the government increased the maximum advances authorized from fr. 21,000 million to fr. 24,000 million. About two months later, on April 24, 191 9, in spite of the protests of the directors of the bank, they raised the authorized limit by another fr. 3,000 million. The government, however, did agree to retire this amount out of the proceeds of the next loan, thus reducing the maximum authorized to fr. 24,000 million, the limit set on February 13, 1919. It was not feasible to keep the agree- ment. At the end of 1919, the total advances authorized were fr. 27,000 million and the amount actually paid to the state was fr. 25,500 million. To this sum, however, must be added treasury bills discounted by the Bank of France for the purpose of enabling the French government to extend credit to its Allies. At the end of 1919 this item amounted to fr. 3755 million, making a grand total of advances by the Bank of France to the state of fr. 29,255 million. At the end of 1 920, advances to the state rose to fr. 26,600 million, and advances to foreign governments fr. 4,180 million, or a total of fr. 30,780 million. (f) Amortization Fund — Plans have been made to reduce this enormous debt of the state to the bank. The law passed on December 20, 1918,^* renew- ing the privilege of the bank to issue notes for 25 years from January i, 1921, made provision for increasing the amortization fund. Under the agreement of September 21, 1914, interest on loans to the government was to rise from i to 3 per cent one year after the cessation of hostilities and the proceeds were to be applied to an amortization fund. The bank was likewise to make a special contribution of 50 per cent of the interest payable by the state on advances to the French government and 85 per cent on "JJze, Gaston, La resistance a remission de papier monnaie. Rev. Sci. Leg. Fin., 1919, pp. 219, et seq. Journal Officiel, Chambre, Debats, pp. 10, 68, et seq., March 7, 1919, containing exchange of letters between the governor of the Bank of France and the Minister of Finance. "Journal Officiel, December 22, 191 8. Digitized by Microsoft® 238 INTEKNATIONAL FINANCE AND ITS REORGANIZATION the interest received on advances to foreign governments. The interest received by the bank on advances to the French govern- ment is as follows: On a permanent loan of fr. 200 million, no interest; on special advances up to fr. 21,000 million, 0.48 per cent; on special advances of the next fr. 3000 million, 0.355 per cent; on special advances above fr. 24,000 million, 3 per cent interest goes to the amortization fund. The law has been made retroactive to January i, 1918. The amount to be contributed by the bank to the amortization fund for the period August i, 191 4, to Decem- ber I, 1917, has been fixed at fr. 200 million.^^ By the end of 1918 the bank had paid in fr. 237 million out of profits on advances to the state and on discounted treasury bills covering advances to foreign governments. The special reserve to amortize advances amounted to fr. 125 million at January 1, 1921, and is estimated to be fr. 800 million at the end of 1921. According to an agree- ment on April 14, 1920, between the Minister of Finance and the governor of the Bank, the limit of the advances should have been reduced by January i, 1921, from 27,000 to 24,000 million francs. This was not feasible, and on December 16, 1920, a new agreement provided that the limit be maintained at fr. 27,000 million till January i, 1922. The government undertook to repay fr. 2000 million before that date and a like sum annually there- after.^" Whether this contract can be carried out unrevised remains to be seen. iv. Loans and Discounts (a) Decline During the War — Loans and discounts, which represent the commerdal activities of the Bank of France, increased from fr. 1527 million on Decem- ber 26, 1 91 3, to fr. 2444 million on July 30, 19 14, owing to the heavy rediscounts by the Bank of France because of the war scare. A very sharp decline followed and on December 10, 19 14, it amounted to only fr. 213 million. Not until after the war did this item reflect the resumption of commerdal activity. On June 27, 1918, there was a rise to fr. 1360 million, and a decline subsequently to fr. 1002 million on August 8, 191 8, and further to fr. 875 million on June 26, 1919. The resumption of " Thackara, A. M., ibid. Also Report of Bank of France, 1918. "Journal Officiel, January a, 1921, Digitized by Microsoft® FRENCH CURRENCY AND CREDIT 239 commercial activity after the war raised loans and discounts to levels higher than before the war; at the end of 1920, the amount was fr. 3311 million. The Bank of France in the crisis before the war as well as in the resumption of trade after the war con- tinued to discount commercial bills and thus enabled banks and private individuals to meet their liabilities. (b) The Rates of Discount — The rate of discount of the Bank of France changed less fre- quently than did that of the Bank of England, because the former is less sensitive owing to its larger gold reserve vdth respect to liabilities, and owing to its smaller dealings in bills and to less necessity of regulating their volume by a varying rate of discount. The highest rate during the war was 6 per cent. On August 20, 1 914, it was reduced to 5 per cent, at which level it remained unchanged up to April 8, 1920, when it was raised to 6 per cent. About the same time the rates of discount of the Bank of England and of the Federal Reserve banks also were raised. The desire to finance the transition by easy money kept the official discount rate low until the spring of 1920. V. Moratorium Bills As commercial discounts declined sharply at the beginning of the war, the item "moratorium bills" appeared — that is, bills matured and extended. These reached a high level of fr. 44.76 million in October, 1914.^^ As moratorium bills declined new commercial bills or loans and discounts rose. The moratorium bills declined from their high level and on December 31, 1914, amounted to fr. 3351 million, on December 30, 1915, to fr. 1834 million, on December 28, 1916, to fr. 1339 million, on December 26, 1918, to fr. 1028 million, on December 26, 1919, to fr. 626 million, and in the middle of 1920 to fr. 523 million.^^ Against moratorium bills at the end of 1919 the Bank of France had securities amounting to fr. 703 million, a sum in excess of its lia- bility by fr. 77 million. " Report of the Bank of France, 1919 ; also Consul Geneial Thackara'a report, p. 19. " From the reports of the Bank of France. Digitized by Microsoft® 240 INTERNATIONAL FINANCE AND ITS REORGANIZATION This continuous decrease in the moratorium bills is an indica- tion of returning financial soundness. The cause of the reduction was the policy of narrowing the extent of the moratorium from time to time, as noted above. The reduction in 191 8 was largely due to the law of July 26, 1918, and the decree of December 29, 191 8, which lifted the moratorium for beneficiaries of war profits and for residents in the interior of the country, who had been able to continue agricultural operations. The moratorium was lifted completely after January i, 1921.^^ vi. Notes in Circulation The three leading belligerents in Europe resorted to issues of paper money. In Great Britain the government itself issued cur- rency notes. In France the government borrowed of the Bank of France and the Bank issued paper money. In Germany the same held true as in France except that new financial institutions, the loan bureaus, were created, and under the law their notes were made the equivalent of cash or gold in affording a basis for the issue of additional Reichsbank notes. Only technically is it true that in France the government did not resort to printing of paper money. (a) Terms of Issue — The notes were issued upon specie, upon statutory and com- mercial loans, upon advances against securities, and upon advances to the state. In France before the war there was no limitation as in England that the notes issued should represent an equivalent amount of gold. Nor did the French system require as in Germany and the United States that there be a fixed ratio of gold and com- mercial bills to notes. This freedom of note issue was a pillar of strength during a temporary crisis but because of its abuse during the war, constituted the essential weakness of the post-war credit and currency situation in France. (b) Forms of Issue — In preparedness for emergencies, the French government had accumulated a large quantity of paper money in advance. This measure recalls those that Germany took in anticipation of the struggle. England on the other hand was so thoroughly unpre- " Journal Officiel, December'30, 1920, Digitized by Microsoft® FRENCH CURRENCY AND CREDIT 241 pared that upon the suspension of specie payment there was a lack of paper money, and postal money orders were made to pass from hand to hand like notes. In addition to the regular large denomination notes of the Bank of France, i -franc and 50-centime notes were issued by the chambers of commerce upon the deposit of an equal amount of Bank of France notes. Furthermore the Bans de Defense Nationale in denominations of 5 francs and 20 francs passed from hand to hand like currency and were used to pay for the delivery of war material. In the loan floated in the autumn of 1920, the bearer bonds with the first 5 coupons attached were issued in a size identical with bank notes. (c) The Continuous Increase in Volume — During the Franco-Prussian War the note circulation hardly doubled. In the 40 years from 1872 to 191 1 the note circula- tion increased from fr. 3200 million to fr. 6800 million, an increase of 2.13 times. In 5 years of the World War the note circulation increased 6.03 times. It would have taken 120 years to attain an equivalent note expansion under pre-war conditions. The notes authorized to be issued were as follows:^* Date Million francs Aug. 12, 1870 1,800 Aug. 14, 1870 2,400 Dec. 29, 1871 2,800 July, IS- 1872 3,200 Jan. 28, 1893 4,000 Nov. 17, 1897 S,ooo Feb. 9, 1906 S,8oo Dec. 1911 6,800 Aug. S. 1914 12,000 May II, 191S 15,000 Mar. IS, 1916 18,000 Feb. 15,1917 21,000 Sept. 10, 1917 24,000 Feb. 1918 27,000 May 18, 1918 30,000 Sept. 18, 1918 31,500 Mar. 1919 36,000 May, 1919 40,000 Aug 1920 43,000 "Economiste Fran;ais, May 24, 1919, pp. 643-5. Paris correspondence London Economist, May 3, 1919. Journal Officiel, Oct. 10, 1920. Digitized by Microsoft® 242 INTERNATIONAL 3?INANCE AND ITS REORGANIZATION The actual issue of notes shown elsewhere below never quite reached the maximum amount authorized. The maximum out- standing was 39,644,392,000 francs on November 3, 1920. The huge increase in the note circulation after the armistice was due to the fact that the French government wished to finance the transition period without burdening the taxpayer or drawing too heavily on the investment market. As a result of the con- tinuous increase in the issues of banknotes prices rose rapidly and when the dangers of the policy of easy financing became apparent public opinion forced the Ministry to resort to taxation. The restoration of the devastated areas required a large outlay and the simplest way to get it was to water the circulation. In this regard the French financial policy was based on a mistaken notion. The monetary functions of the state, or the right to issue notes, were confused with the fiscal function, or the power to raise funds. This was true not only in France. Whereas France relied on note issues. Great Britain relied on ways and means advances from the Bank of England and upon the issue of Currency Notes. vii. Minor Operations of the Bank of France Among the minor operations of the Bank of France was the reimbursement to business houses for the loss of credits to Russia. It also acted as agent of the state in helping to float the loans. Of the fr. 30,000 million of the loan floated in 191 8, 45 per cent was subscribed through the Bank. Furthermore, in the mobiliza- tion of securities the Bank aided in the transfer to the French Treasury of the French holdings of bonds of neutral countries. The bonds were received in all the branches of the Bank and the amount received by the end of 1 91 7 aggregated 774,140 securities with a par value of about fr. 640 million.^' The Bank was largely instrumental in furnishing exchange at fixed rates for the accom- modation of the commerce of the country. It also aided the Treasury in controlling the exportation of capital and the impor- tation of securites. D. The Effects of Inflation The efiects of inflation in France were similar to those experi- enced during the French Revolution, and to the effects in other "Bank of France report, 1917. Digitized by Microsoft® FRENCH CUKRENCY AND CREDIT 243 countries during the World War. The overissue of paper money led to its depreciation, to a rise in prices, and an increase in the cost of living and of the administration of the government. The foreign exchanges likewise depreciated. Government credit declined both at home and abroad. As the purchasing power of the franc de- clined, the public debt rose, increasing rapidly. Speculation and profiteering were rife. Legislation fixing prices was evaded. As paper depreciated metallic currency rose to a premium and when prohibitive legislation was enacted, specie was hoarded or melted. Paper money of small denominations had to be issued to replace the vanished currency. To reduce the need for currency the govern- ment and private bankers attempted to popularize the use of checks. Inflation was reflected in the private banks to a limited extent. i. The Rise in Prices While the opponents of the quantity theory of money affect to see other causes than the increase in the notes outstanding, this factor undoubtedly was the chief cause of the rise in prices. Im- portant factors, other than the increase in the quantity of money were, the pressing demand of the government for goods, the dis- location of labor, the occupation of the coal fields and of the in- dustrial regions of northern France, and the shortage in shipping. However the correspondence in the several countries between the increase in notes outstanding and the rise in prices is so close, as shown in tables on page 187 as to leave no doubt as to the prime cause of the price advance. The table of prices by quarter years from 1913 through 191 8 and by months during 1919 and part of 1920 shows a rapid in- crease through 19 1 5, a moderate increase through 191 6, again a rapid increase through 191 7, and still more rapid increase through 19 19 and part of 1920. The increase of prices between the last quarters of successive years, using the average prices from July, 1913, to June, 1914, as a basis of lOO, was as follows: 1913-1914 8 1914-191S SI 1915-1916 41 1916-1917 96 1917-1918 63 Jan., 1919-Jan., 1920 139 Jan., 1920-April, 1920 97 Digitized by Microsoft® 244 INTERNATIONAL FINANCE AND ITS REORGANIZATION The following table shows differences between wholesale prices in France and the United States through the year 191 8: Index Numbers of Wholesale Prices in France and the Uotted States, BY Quarters and Years, 1913-1918" By Quarters By Years France* u. s.t Differ- ence France U.S. Differ- ence France U.S. Differ- ence 1913: 1916: 1913: lOI 102 — I 180 118 62 100 lOI — I lOI 100 I 191 123 68 1914: 100 lOI — I 187 I2S 62 102 99 3 99 102 -3 199 139 60 191s: 1914: 1917: 140 102 38 100 100 224 152 72 1916: lOI 97 4 258 177 81 189 126 63 lOI 100 I 274 187 87 1917: 107 98 9 29s 182 "3 263 I7S 88 1915: 1918: 1918: "S 100 25 321 187 134 339 194 145 136 100 36 334 190 144 142 I02 40 348 197 151 158 107 SI 358 202 iS6 •General Statistical Office. fPrice section, War Industries Board. -' Mitchell, Wesley C, International Price Comparisons, Department of Commerce, Washington, D. C, 1920. Digitized by Microsoft® FRENCH CURRENCY AND CREDIT 24S Subsequent figures of prices for the months of 1 9 19 and 1920 arc given herewith, with the differences between the prices in the United Statesiand France, and also slightly different figures, from another source, for the years 191 3 to 1918.^' Comparative Price Indexes (Index for 1913 = 100) Year U.S.* France t Difference 1913 1914 191S 1916 1917 1918 1919: January April 100 100 lOI 124 174 197 203 203 218 223 248 26s 262 22s 189 100 lOI 137 187 262 339 348 332 349 382 487 584 496 S02 434 I 63 88 142 US 129 13X 159 239 319 234 277 24s July October 1920: January April July October December *U. S. Bureau of Labor Statistics. tBulIetin de la Statistique Generate. In view of the fact that the United States was a free gold market, except during the period of the gold embargo from Oc- tober, 191 7, through May, 1919, the gap between prices in France and in the United States is a true measure of the depreciation of paper in France. The great difference which became evident in 1920 shows the full effect of the huge volume of note issues put out by France. The difference between prices in the United States and Great Britain is far smaller, as the result of Britain's prudent post-war policy in issuing notes. The circulation of the notes of the Bank of France by approximately quarter years is given here- with. The parallelism between the increases in notes and the in- creases in prices is evident. " Federal Reserve Bulletin, August, igao, and February, igzx. Digitized by Microsoft® 246 INTERNATIONAL FINANCE AND ITS REORGANIZATION Notes of Bank op France in Circulation (in million francs) Date Million Relative Date Million Relative francs figures francs figures 1914 1918 July 30.... 6,683 100 Mar. 28. . . 25,179 378 June 27. . . 28,550 423 191S Sept. 26... 29,922 448 Jan. 28 10,474 157 Nov. 28... 29,072 43S Mar. 25 11,177 168 Dec. 26... 30,250 453 June 24 I2,IOS 181 Sept. 30. . . . 13.458 202 ^^i? Nov. 25 14,278 214 Mar. 27. . . 33,372 500 Dec. 30 13,309 199 June 26. . . 34,442 51S Sept. 25... 35.787 536 1916 Dec. 26. . . 37,274 558 Mar. 30 14,952 224 June 29 15,806 237 1920 Sept. 29 16,714 250 Mar. 25 . . . 37,569 563 Nov. 30 16,119 241 June 24. . . 37,544 562 Dec. 28.... 16,679 250 Sept. 30. . . 39,208 588 Dec. 31 . . . 37,902 567 1917 Mar. 29 18,460 276 June 28 19,823 297 Sept. 27.... 2o,99S 315 Dec. 26.... 22,337 334 ii. Economic Disturbances The rise in prices was the result of natural law. Nevertheless legislators, ignoring the cause of the difficulty, attempted to cope with it by regulating prices despite the fact that the history of the currency and of prices in the French Revolution affords abundant evidence of the limitations of such measures. Prices were fixed on some commodities and as a result capital and effort were shifted from the field of fixed prices into that of free prices. When the price of wheat was fixed, farmers planted oats. Or they sold oats for a profit and fed wheat to their stock. Subsequently when a law was passed prohibiting the feeding of wheat to animals, other means of evading the price legislation were devised. Farmers then held back and refused to sell or they bartered their produce for commodities. Profiteering in commodities was widespread and the benefits did not flow to the government in taxes as in Great Britain and the United States where stringent excess-profit taxes were Digitized by Microsoft® FRENCH CURRENCY AND CREDIT 247 enacted and administered. Speculation increased as a result of the rise in prices. Stocks rose in proportion to the decline of the pur- chasing power of the franc. Bondholders found their incomes de- clining in purchasing power. The whole gamut of historic economic disturbances were repeated. iii. Depreciation of Foreign Exchange The effect of inflation on foreign exchange will be treated in a separate section. It is sufficient to note here that the exchange rate of the franc abroad declined in the free gold markets pari passu with the depreciation of the notes at home. That francs did not so decline in Great Britain or in the United States during the period of our belligerency was due to the artificial support of French exchange in the London and New York markets respec- tively. The reason for the depreciation is evident. As an incon- vertible note depreciates in terms of gold at home so an incon- vertible bill of exchange depreciates internationally. When gold quotations were published in 1920, the depreciation of foreign ex- change in dollars corresponded closely to the discount on paper. The absence of gold as a corrective, or the removal of the gold shipping points which limited fluctuations, made depreciation on the international markets inevitable. Just as the attempt to maintain a depreciated franc at par in- ternally worked hardship on certain classes and led to evasion, so the attempt to hold a depreciated franc at par internationally led to hardship and injustice. In the competitive international market for commodities, the franc fell to its natural level. But in the monopolistic market for cable services the government regarded the franc as the equivalent of its pre-war value in gold. As a result, the Western Union Telegraph Company refused to accept messages out of France for the United States unless paid on the gold basis. The French government, however, claimed that the depreciated paper franc was legal tender and had to be accepted at its mint parity. The Western Union Telegraph Company did internationally what the French farmer did internally, namely, re- fused to sell at fixed prices in depreciated paper.^* "'New York Times, December 10, 1920. Digitized by Microsoft® 248 INTERNATIONAI, FINANCE AND ITS REORGANIZATION iv. Premium on Specie The inevitable result of the excessive issue of notes was the appearance of a premium on specie. Originally, gold and silver wrere traded in illegally and sub rosa in much the same way as gold was speculated in frankly and legally in the Gold Room after the Civil War. When speculation was detected, legal penalties were imposed. Cases of detection were unusual, however. The law- abiding Frenchman, however, was able to invent means of cir- cumventing the law. Instead of exchanging his specie for notes at a premium, he melted the coin and sold the gold. Then a new law was passed which prohibited the melting, recoinage or withdrawal from circulation of metallic money, under penalty of a fine of 5000 francs and imprisonment up to six months. The legislation pro- hibiting the hoarding of gold and requiring its surrender for notes led to some absurd situations. For instance, American paper money had a higher value than American gold money in France, because the law required gold to be surrendered. The difference was about 3.86 cents on the dollar.^' The depreciation in paper was com- plicated further by the rise in the price of silver and silver was bought up illegally at 1.5 times its face value and was hoarded. New metallic coins put out by the mint vanished upon issue. However, in 1920 quotations for gold were published. They measured the depreciation in terms of paper money as truly as the foreign exchange rates in terms of dollars. A kilogram of find gold is worth 3437 francs at parity, but it was quoted at 1 1,200 francs per kilogram on May 5, 1920, or 3.26 times parity and at 7,800 francs on July 21, or 2.37 times parity.^" Dollar exchange at Paris and prices of gold moved in close sympathy. V. Shortage of Specie and Demonetization As a result of the influences mentioned there was a shortage of small change. Not only were gold and silver scarce but copper and nickel as well. When the copper sous disappeared in 191 7 the government put out 15 million nickel coins in replacement but "From Governor Harding's testimony before the Senate Committee on Banking and Currency in its hearings on the Federal Reserve Foreign Bank Bill. Federal Reserve Bulletin, August, 1918, p. 726. " Statistiques Ginirales, ix: iv, July, 1930, p. 331, and x: i, October, 19K>, p. 38. Digitized by Microsoft® FRENCH CtTRRENCY AND CREDIT 249 these disappeared shortly after their issue. Restaurants in Paris posted notices that customers would either have to bring their own change or accept postage stamps. To relieve the shortage the gov- ernment decided in the autumn of 19 17 to demonetize certain coins, declaring them no longer current and calling for their surrender. vi. Issue of Paper Money of Small Denominations As gold and silver disappeared from circulation in the early part of the war the local chambers of commerce issued notes of i franc and yi franc to replace the small change which disappeared. These notes were secured by notes of the Bank of France of a larger denomination. In the course of circulation these notes would be returned to the issuing authority by the Bank of France. The Paris Chamber of Commerce issued fr. 15 million in denominations of 2-franc, I -franc and 50-centime notes, which were put out at the rate of fr. 200,000 per day during the summer of 1920. Again, the smaller denominations of treasury bills, bons de la defense nationale, were used as currency and passed from hand to hand like notes. This device is strikingly similar to the use of interest-bear- ing mandat of the French Revolution or our Continental cur- rency. ^^ Apparently the lessons of history are of no avail. The small denomination bonds of the loan floated in October, 1920, were identical in size with banknotes and were intended to pass as currency while accumulating interest to the holder. They had five interest coupons attached. In this respect they were similar to an issue during the Civil War. The difficulty we experienced was that the notes were very scarce at the time that the accrued interest made it worth while for investors to hoard them, and be- came abundant immediately after the payment of interest. The result was an embarrassing alternation of expansion and contraction of the currency.^^ The extensive use of paper money wore it out very rapidly and token money made of an alloy was substituted in the spring of 1920. This had a metallic ring but was not of suffi- cient value to melt or smuggle out of the country or even to hoard. The distinctive feature of the new coins was that they were more durable than paper. They were also issued by the chambers of *" White, Horace, Money and Banking, pp. 134 and 158. For illustrations of emergency coinage and notes see Benjamin White, Currency^ of the Great War. London: Waterlow and Sons, Ltd.: 1921. "White, Horace, ibid., p. 158. Digitized by Microsoft® 250 INTERNATIONAL FINANCE AND ITS REORGANIZATION commerce and were secured by equivalent amounts of Bank of France notes. vii. Tke Disruption of the Latin Monetary Union^" The Latin Monetary Union was an attempt to unify the mone- tary systems of several countries and it accomplished this purpose effectively before the virar. In addition it diminished the slight fluctuations of exchange rates because the currencies of the countries in the union circulated interchangeably. However the war upset the basis of the union. The similarity between the French franc and the Swiss franc became one of name only. Because of the depreciation of the French franc Switzerland was flooded with depreciated French coins. The result was a surplus of currency in Switzerland and a shortage in France, which in part accounts for the measures described above. To overcome this difEculty the Convention of 1885 of the Latin Monetary Union was revised with the object of withdrawing the depreciated French coins from Switzerland. The revised terms of the Convention are given herewith :^* Article i. The French and Swiss governments shall each withdraw from circulation on their respective territories all silver coins of the other country of the value of two francs, one franc, fifty centimes, and twenty centimes. Article 2. Such coins are to be no longer received in public payment when three months have elapsed from the entry into force of the con- vention. Article 3. The coins so withdrawn from circulation are to be put at the disposal of the state of their origin. Article 4. Switzerland is to be given the right of increasing the con- tingent of small silver coin per head of its population from sixteen to twenty-eight francs. Article 5. Switzerland may reserve the quantity of French coin she judges indispensable for her own needs from the amount by which the French coin in Switzerland exceeds the amount of Swiss coin in France; Switzerland may centralize the coin so reserved and use it as a guarantee for an equivalent amount of two-franc, one-franc, and fifty-centime notes, which she is entitled to issue on it. Unless arrangements to the con- trary are made in the meanwhile all French coin reserved by Switzerland "Lansburgh, A., Der Lateinische Miinzbund, Die Bank, June, 1920, pp._ 343-363. See also Willis, H. Parker, Genesis of Latin Monetary Union, Chicago, 1901, and History of Latin Monetary Union, Chicago, 1901. "Report of the British Minister to Switzerland, Board of Trade Journal, June 10, 1920, and August 12, 1920. Digitized by Microsoft® FRENCH CURRENCY AND CREDIT 2SI is to be placed at the disposal of the French government four years after the entry into force of the convention. . . . Article 8. Switzerland is to inform France of the quantities of coin eventually reminted. For such excess of French money as France imme- diately receives from Svritzerland, France undertakes to repay Switzer- land, as also for such centralized French money as Switzerland may re- turn her at the end of four years. Repayment may be affected at France's choice either in the coins of the Latin Union, preferably Swiss, or in gold coin of ten francs and upwards, or in bills on Switzerland. Article 9. Each government is to bear the cost of collecting and re- storing the coin of the other government. Article 11. So long as each country refuses to accept the coin of the other in public payment, each country may also interdict the importation of the other's coin. Article 14. The governments of the contracting countries agree to take measures to prevent the clandestine melting-up of coin emanating from countries belonging to the Union. French silver coins in the denominations of 2 francs, i franc and 50 centimes have accordingly been withdrawn from circulation in Switzerland with the concurrence of France. During September, 1920, French paper was depreciated 58 per cent in Switzerland; consequently silver coins were smuggled from France into Switzer- land in spite of the maintenance of guards on the Franco-Swiss frontier. Under the agreement the federal treasury in Berne acted as the receiving and assaying station for the French coins. Over fr. 16 million were returned to France within 60 days, and in the transactions at the Swiss Federal Mint the quantity of silver turned in was three times the amount of silver coins asked for in exchange, a fact which indicates the redundance of silver. France settled for the French coins repatriated by means of bank drafts in Swiss francs. The time limit on the exchange of coins was September 30, 1920, and holders after that date had to stand the loss. Judg- ing from the fate of the Latin Monetary Union, the proposals for a world currency after the war seem futile. viii. Popularization of Checks It is an error to assume that excessive note issues lead to in- flation any more than excessive bank credits. The condition of the Bank of France would not be greatly affected if the liabilities were shifted, if deposits were increased and notes correspondingly de- creased. The attempt to popularize the use of checks in France resulted from a mistaken notion that the rise in prices was due to the circulation of paper. Deposit banking has the advantage that Digitized by Microsoft® 2S2 INTERNATIONAL FINANCE AND ITS REORGANIZATION the physical difficulties are less when inflation is produced by de- posits than by checks. The attempt to develop deposit accounts and payments by check dates back to 1859 when the Credit Industriel et Commercial was established. Other companies were founded later, as the Societe Generale and the Credit Lyonnais. However, the association of monetary value with physical tokens was so deep-rooted in the minds of the' French public that the attempts were not successful. The Chambre de Compensation, the leading clearing house estab- lished in 1872, fell into disuse, particularly because of the system of credit transfers through the Bank of France. The desire to dispense with the huge amount of currency and small change that became necessary as the result of inflation during the war led to a revival of the clearing-house scheme, and a Caisse de Compensa- tion formed in July, 1917, for the use of the British and American banks, was merged in a new Chambre de Compensation, an organ- ization with a larger membership. It has been unsuccessful in overcoming the preference of the French public for notes and its prejudice against payment by check.^** ix. Private Banks Affected A few of the distinctive features of the French banking system have some bearing on a study of the effects of the war on the French private banks. Because the French relied on notes rather than on deposits as a means of transacting business, the huge in- flation in France did not result in an increase of the deposit credits of the private banks, as in Germany and Great Britain. The private banks were over-cautious in extending credit to their cus- tomers, and as a result the funds for war had to come from notes of the Bank of France and from short-term treasury bills. Had the banks adopted a more liberal commercial policy during the war, particularly in view of the availability of rediscounting facili- ties at the bank of France, the financing of the war would have been easier. As a result of this imprudently conservative policy in granting credit, acceptance liabilities declined. The balance sheets of the private banks show that they did not support French com- merce and industry during the war. In fact, the availability of re- munerative government paper probably accounted for the reluctance "^ Economiste Fran(ais, Ixviii: i, pp. 75, 203, 329, 491, 649, 779. Digitized by Microsoft® FEENCH CURRENCY AND CREDIT 253 of the private banks to buy commercial paper. Treasury bills were liquid assets, because the Banis of France would rediscount them or else make loans against them as security. The item "bills dis- counted," included short-term government securities as well as com- mercial bills, as in the case of the German private banks. The following are the principal items as of December 31 of each year, from the consolidated statements of the three largest banks, the Credit Lyonnais, the Comptoir National d'Escompte de Paris, and the Societe Generale pour Favoriser le Developpement du G)m- merce et de I'lndustrie en France :'^ PEiNcrPAL Items of Consolidated Statements op the Three Large Banks op France (in million francs) Assets 1914 1915 1916 1918 1919 Cash in vaults and balance at banks. ..... Bills discounted and short-term national defense securities Debits in current account Advances on securities, including stock ex- change loans. Securities, including rentes Financial participations Forward exchange operations 3494 1464 1058 63 75 1309 1298 920 69 73 rgiz 103s 682 93 2S3I lOII 636 86 61 178 1256 3804 I190 632 81 57 108 859 4636 1528 588 79 55 208 1064 8299 2581 748 82 5S 227 Total (including items omitted above) Liabilities Capital paid in Reserve Credits in current account Deposits (checking accounts, deposit certifi- cates payable at sight, discount a/c) .... Deposits payable at fixed date Acceptance liabilities 700 329 3067 2071 297 493 700 343 2213 1355 320 150 700 334 2074 1336 304 114 700 268 2442 1660 299 89 700 269 3576 2r92 285 92 8373 3918 2579 280 54 13,651 700 29s 7288 4167 302 173 Total (including items omitted above) 7174 5934 8373 13,651 A few of the outstanding features of this statement reflect the effects of the war. Cash in vault increased as a result of inflation. Commercial bills and treasury bills declined greatly in 1914 and did not regain their pre-war level until 1917. In 1918 and 1919 this item increased, particularly as a result of the resumption of commercial activity and also because of the extensive issue of short- term treasury bills after the armistice, when long-term loans could not be floated. Advances on securities declined and did not regain the pre-war level. Apparently less business was done in this field. Securities, including rentes, naturally rose in volume, as a result of "^ Federal Reserve Bulletin, October, 1920. Digitized by Microsoft® 254 INTERNATIONAL FINANCE AND ITS REORGANIZATION the issue of war loans. Profits from underwriting declined during the war, because of the restriction on capital issues. Forward ex- change operations, which reflected the activity of the Bank of France in supporting the exchange market, showed a large and continuous growth throughout the war. Debits in current account declined during the war but regained the pre-war level at the end of 1918. Credits in current account, as well as demand deposits, declined in 1914, regained their pre-war level by the end of 1917, and grew continuously thereafter. At the end of 1919 the effects of the in- dustrial revival were evident. Both these items had risen to double their pre-war level. Acceptance liabilities greatly declined, prob- ably in connection with the reduced volume of private trade of France. Time deposits, a small item, remained practically stationary throughout the war. These conclusions are more obvious in the following table of relative figures for the important items: Relative Figures of Important Items op the Consolidated Statements OP Three Large Banks of France ASSKTS Cash in vaults and balance at banks. ..... Bills discounted and short-term national defense securities Debits in current account Advances on securities, including stock ex- change loans Total Liabilities Credits in current account Deposits (checking accounts, deposit certifi- cates payable at sight, discount a/c) Deposits payable at fixed date Acceptance liabilities I9I3 I914 191S 1916 1917 1918 100 256 212 218 266 183 100 IQO 37 89 ss 71 72 69 109 81 133 104 100 87 64 60 60 5S 100 73 73 84 106 "9 100 72 68, 79 117 12S 100 100 100 65 108 30 6S 103 23 So lOI 18 106 96 19 125 94 II I9I9 226 238 76 193 238 203 Z02 3S E. The Outlook The outlook in France depends upon the ability of the Bank of France to reduce its note circulation and to eliminate from among its assets the large advances on government account and on account of its allies. As in our Civil War period there are two parties, one of which hopes to "stabilize" the currency at its present value; the other party expects to reduce the currency either by a slow process of annual amortization out of taxes or else rapidly out of large loans. Digitized by Microsoft® FRENCH CURRENCY AND CREDIT 2$$ i. The Expansion of Production to Absorb the Increased Currency In the 43 years from the end of the Franco-Prussian War to the beginning of the World War, the maximum note issues author- ized increased about twofold. In the five years since the outbreak of the war the currency increased over sixfold. If the outstanding circulation at the end of the war is to be maintained, it will require at least lOO years at the pre-war rate of progress for production to increase sufficiently to require the present currency. The reduc- tion of inflation by building up assets in back of the token of value will be a very long process. The rate of progress for several years after the war will certainly not be equal to that in the decade or two prior to the war. At best the whole period will be one of inconvertible paper, which implies wide fluctuations of ex- change, the unsettlement of trade and the absence of sensitive regulation of trade, such as is possible when gold flows freely. During the Franco-Prussian War, the advances to the state amounted to fr. 1470 million, a mere bagatelle against the fr. 26,600 million maximum outstanding at the end of 1920. And yet it took 7^ years, until January i, 1878, to resume specie pay- ment. If it required y}^ years to resume specie payment when ad- vances to the state amounted to only fr. 1470 million, assuming the same rate of progress it would require over 130 years to get rid of the inflation resulting from fr. 26,600 million in advances to the state. ii. Deflation of the Currency The deflation of the currency is the more advisable course. This may be accomplished either by means of annual payments out of an amortization fund, or out of loans. M. Maurice Casenave estimated that fr. 2 billion a year would be available for the re- duction of the advances to the state and therefore that the in- flated circulation could be reduced to its pre-war basis in about I2 years.^^ However, M. Casenave's estimate seem to be too high. The date of retirement of the first annual amount was postponed for a year from January i, 1921. In the autumn of 1920, the annual " Casenave, Maurice, The French Situation. Proc. Acad. Pol. Sci., ix : I, p. 104. June, 1920. Digitized by Microsoft® 256 INTERNATIONAL FINANCE AND ITS REORGANIZATION sum available for amortization of the debt of the state to the Bank was estimated at fr. 300 million. To reduce the paper currenq^, amounting to fr. 39,000 million, to its pre-war level would require over 100 years if the same rate of amortization were maintained. Apparently amortization by means of annual payments of in- terest on the note issue by the state will not deflate the currenq^ as rapidly as is desirable. It is therefore necessary that long-tenn loans be utilized for this purpose. The French government ex- pects to retire 2,000 million francs annually. The success of this policy rests on many factors, the rate of rebuilding of the de- vastated areas and the balancing of the budget. These two factors are closely related because a large section of the budget is ofFset by a credit called, "Expenses recoverable from. Germany under the Treaty of Peace." Whether this section of the budget is to be balanced depends on Germany's recovery, which in turn is con- tingent on the removal of the obstacles to the restoration of normal conditions in Germany. In this task France has the power of de- cision and the responsibility therefor. iii. Analogy of the Civil War M. Casenave, in the address, quoted above, compared France after the World War with the United States after the Civil War. There are a few interesting statistics that will make clear the differences. In 1865 the debt of the United States was $268 i million and the note circulation was $715 million.^^ With a»population of 30 millions the per capita debt was about $90 and the per capita note circulation about $24. The period of inconvertible paper was 14 years, resumption of specie payment taking place in 1879. In the middle of 1920 France had a debt of fr. 233,000 millions and a note circulation of about fr. 39,000 million. Or taking francs at par the national debt of France was 46,600 million dollars and the note circulation was the equivalent of 8000 million dollars. With a population of 40 millions the per capita debt was the equivalent of $1165, or 13 times the per capita debt in the United States after the Civil War, and the note circula- tion was the equivalent of $200 per capita or about 8 times the United States figure after the Civil War. Assuming the rate of "Mitchell, Sound Currency, vol. iv, No. 8, Hepburn, History of the Currency in the United States, p, 204. Digitized by Microsoft® FRENCH CTXRRENCY AND CREDIT 2S7 progress of the United States after the Civil War, it would take France from H2 to 182 years to resume specie payments, depend- ing on whether notes in circulation or public debt is taken as a basis of calculation. iv. Possible Remedy This conclusion is manifestly absurd. Many of the calculations with respect to the war itself failed to take into account non- mathematical factors. It may be that for France the ultimate solution would be a forced conversion and reduction of the rate of interest on the debt, a re-valuation of the franc, and the adoption of the gold-exchange standard, under which international gold settlements would be effected but not internal gold settlements. The arguments for this proposal are many. The injustice and the evils of inflation are a matter of the past. The harm is done. To attempt to deflate would be a proposal to enrich the speculators, both native and alien, by means of taxes paid by Frenchmen. This tax must necessarily fall on the masses because the taxation of wealth dries up the sources of capital and retards industrial develop- ment. Deflation therefore involves a second grave injustice. To revalue the franc near its current gold quotation and to start with a dean slate involves no greater Injustice and may mean the resur- rection of the nation from the ashes of war. Digitized by Microsoft® CHAPTER VIII GERMAN CURRENCY AND CREDIT A. History of the Reichsbank i. Development of the Central Bank A brief history of the development of the Reichsbank^ is helpful in understanding the war-time developments in German currency and credit. The Reichsbank is an outgrowth of the Bank of Prussia and has practically a monopoly of the right to issue notes, except that the privilege is still retained by four private banks. The Bank of Prussia was founded in 1765 as a state institu- tion. Even after it subsequently became a partly private institution in 1846, the control was vested in a Kuratorium, composed of representatives of the king. Originally, the Bank of Prussia was primarily a bank of issue, only later becoming a bank of dis- count and deposit. A precedent for the Darlehnskassen, the loan bureaus, established during the World War, is afforded by the practice of the Bank of Prussia, subsequently retained by the Reichsbank, of advancing money on commodities and on bullion and pledged securities at conservative valuations and for limited periods. The law of 1846 provided for, but fixed a limit upon the issue of notes, but this latter provision was thereafter repealed and the traditional banking ratio of one to three between the metallic reserve and the note circulation governed the note issue. At the time of the establishment of the Reichsbank in 1875, there were in the several German states thirty-three other banks of issue, many of which were born of the fiscal needs of their governments. To promote trade among the German states and with foreign countries the currency was unified. The payment of the indemnity ' Conant, Chap. viii. Lansburgh, Alfred, Die Deutsche Bank, 1870 bis 19*0. Die Bank, pp. 259-a6£. 258 Digitized by Microsoft® GERMAN CUKKENCY AND CREDIT 259 by France enabled Germany to adopt the gold standard. The mark was made the monetary unit, although German economists had recommended the five-franc piece adopted at the International Monetary Conference at Paris in 1867. Silver coins, which had previously been legal tender, became token money, with limited legal tender privileges, except for the silver thaler until its demon- etization in igo2. ii. Organization and Function of the Reichsbank As a result of Prussian and imperial legislation and of a con- vention between Prussia and the empire, the Royal Bank of Prussia ceased to function at the end of 1875 and transferred its rights and privileges to the newly formed Reichsbank, which, though privately owned, is under government direction. The bank is controlled by a council of curators, of which the president is the Imperial Chancellor and the members are named by the emperor and the Bundesrat. In the absence of the chancellor another official of the empire acts. The council of curators holds quarterly meetings. The administration of the Reichsbank is vested in the directorate, nominated by the imperial government. The stock- holders have an advisory board of fifteen members, elected from among their number, one-third being chosen annually. They hold monthly meetings and advise on policies affecting the rate of dis- count and like matters. An executive committee of three has daily supervision of the bank's affairs. Unlike the Bank of England, the Reichsbank has not a fixed fiduciary circulation, but against outstanding notes one-third of the amount must be in cash. A limited amount, Kontingentj may be issued without cover, and above this limit notes are under a tax or penalty, which hastens their retirement. Like the Bank of England,' the circulation of the Reichsbank may be increased upon the surrender of the privilege of issue by any of the other issuing banks. The Reichsbank may expand its note circulation in time of need without furnishing metallic cover, by paying a tax weekly at the rate of 5 per cent per annum. This tax makes possible the expansion of the circulation in a crisis, but promptly retires it when the discount rate falls. The charter of the Reichs- bank expired at the end of 1920 and the new law extending the charter gave the bank wider powers in dealing with foreign Digitized by Microsoft® 26o INTERNATIONAL FINANCE AND ITS REORGANIZATION exchange and provided for larger government participation in the profits of the bank.'' iii. Control and Concentration of Gold Supply To centralize its gold reserves and to increase its control over the movement of gold, the Reichsbank developed several devices. To avoid the exportation of gold during the period of high exchange rates, the bank wrould buy foreign bills vrhen exchange was cheap and would resell them w^hen exchange rose sufficiently to produce an outflow of gold. Again, gold imports were encouraged by exempting advances upon them from interest charges for a limited period. To meet the demand for currency for quarterly settlement in business, the issue of uncovered notes, free from taxes, was in- creased during the last weeks of each quarter of the year and thus lessened the demand for gold coin. To economize in the use of gold the Reichsbank encouraged the development of the system of Giro Verkehr, whereby deposits at any branch of the Reichsbank were transferred without charge to a branch in another town. This is analogous to the check and clearing system in the United States. The Reichsbank also adopted the customary practice of maintaining a high discount rate to attract gold. The central gold reserve was built up shortly before the war by substituting notes of small denominations for specie and by bidding high for gold in the world market. B. War Legislation, Policy and Expedients' i. Suspension of Specie Payment Upon the outbreak of the war specie payment was suspended. To centralize the gold of the country in the Reichsbank notes of 50 and 20 marks were issued under the law of 1906, prior to which date the lowest denomination was 100 marks. Finally mk. 120 million of silver token money was authorized to be coined, 'Report of the Reichsbank for the year 1919. Liesse, Andri. _ Le Renouvellement du Privilege de la Reichsbank. Economiste Fran^ais, January 31, 1920, pp. 3-5. "Bendix, Ludwig, Germany's Financial Mobilization. Quarterly Journal of Economics, xxix, pp. 728, ei seq., August, 1915. Going, Chase M., German War Finance. Journal of Political Economy, xxiv, pp. 513-547, June, 1916. Digitized by Microsoft® GEEMAN CURKENCY AND CREDIT 261 to replace gold in circulation. Reichsbank notes were no longer redeemable in gold. The Imperial Treasury was released from the requirement to redeem subsidiary cgins in gold, but was per- mitted to exchange them for irredeemable Reichsbank notes and Imperial Treasury notes. The Treasury likewise was released from the obligation to redeem its own outstanding notes. To protect the gold reserves of the private note-issuing banks, they were allowed to redeem their notes with Reichsbank notes. Thus all currency became inconvertible. ii. Imperial Treasury Notes Issued Furthermore, to provide notes of small denominations, govern- ment paper money, Reichskassenscheine, was issued in denomina- tions of 5 and 10 marksi As a result of legislation, the war chest of mk. 120 million was doubled by the sale of Imperial Treasury Notes, Reichskassenscheine, for gold. These were made legal tender and their acceptance made compulsory. The original mk. 1 20 million were authorized April 30, 1874, another 120 million on July 3, 1913, and an additional 120 million on March 22, 1915, the last being fully covered by gold or loan-bureau notes. Like the British currency notes, their object was to provide bills of small denomination. iii. Increased Issue of Reichsbank Notes The policy of German war finance was to raise large sums of money through the Reichsbank. Under the terms of the banking law notes were issued against cash and bills of exchange in the proportion of one-third and two-thirds. The war policy required an increase of bank notes and to meet the need, new definitions of cover were made. Before the war, cash consisted of gold, silver, and a limited amount of Imperial Treasury notes. To create "cash" the Imperial Treasury note issue was increased and the notes of the loan bureaus, Darlehnskassenscheine, were author- ized as equivalent to cash. To meet the demand for bills of exchange as cover for notes, the bank law of March, 1875, which required discounted bills of exchange maturing in three months and bearing two responsible names as guarantors, was modified Digitized by Microsoft® 262 INTERNATIONAL FINANCE AND ITS REORGANIZATION by the law of August 4, 191 4, which provided that in lieu of commercial bills, which would be available in diminishing volume during the war, the Reichsbank should regard as bills of exchange treasury bills, bearing the signatures of two members of the National Debt office and maturing within three months. In brief, for gold and for commercial bills as cover for notes, there were substituted respectively notes of the loan bureaus and short-term treasury bills. Inflation might thus be unlimited. The Reichs- bank was also authorized to buy, sell and discount three-months treasury bills. The same act likewise repealed for the period of the war the provision for a tax of five per cent per annum upon the uncovered amount of circulating notes above the legal amount, Kontingent. However, the facility in creating cash reserves by issuing loan- bureau notes made this provision almost superfluous.* iv. New Institutions to Create Credit Several types of credit institutions were created for the purpose of liquefying or mobilizing the financial resources of the country. The Reichsbank aided the larger firms and the banks. The loan bureaus, Darlehnskassen, aided the smaller tradesmen or the individuals who possessed any values that might be pledged. Muni- cipal loan bureaus were established to make loans on securities unacceptable at the regular loan bureaus. The rates of interest were higher and a guaranty fund was raised by cooperative societies and the local community. These institutions did not issue notes, but expanded their activities by rediscounting at the Reichsbank and the Kriegskredit banks. The Kriegskredit banks were organized by banks, chambers of commerce and public bodies. These institutions made loans based on unsecured notes and on goods or bills of exchange, which in turn were rediscounted at the Reichsbank. The Kriegskredit banks could not issue notes. The Darlehnskassen were the outgrowth of the practice of the old Bank of Prussia and of the Lombard department of the Reichsbank (Par. 3, Sec. 13 of Bank Act), of making loans on commodities or on securities. The loan bureaus themselves were actually tried out in Prussia as separate institutions during three •Laws No, 4333, 4434, 4435, 4446, 4448, of the Reichgesetzblatt Digitized by Microsoft® GERMAN CURRENCY AND CREDIT 263 wars, in 1848, In 1866, and in 1870. Similar institutions were established in France in 1830 and 1848 but they had not. the privilege of issuing notes. The loan bureaus were under the con- trol of the Reichsbank. Except in rare cases, loans were made for not less than ICX3 marks in amount and for not more than three months in time. The security might be either non-perishable merchandise stored within Germany on which a loan of 50 per cent was allowed, securities issued by the empire or by a federal state, or securities conforming to specified requirements and issued by corporations within the empire, on which loans of from 60 to 75 per cent were made. According to the law, the rate of interest was not to be higher than the Reichsbank rate for bills. The loan bureau had the right to sell the security and reimburse itself out of the proceeds. The loan was made in the form of loan- bureau notes, Darlehnskassenscheine, which were issued in denomi- nations of I mark and upward. They were counted as cash in the reserves of the Reichsbank like gold and imperial treasury notes. Unlike the currency notes of Great Britain or the Bank of France notes, there was no gold cover in back of the German loan-bureau notes. However, if the security should be inadequate to pay the loan when due, the loan bureau had recourse to zH the assets of the borrower. v. Moratorium The liquefaction of the fixed assets of Germany made it unnecessary to declare an official moratorium. However, there is little difference between declaring a moratorium when liquid assets are not available and liquefying fixed assets to avoid a moratorium. England and France followed the former policy and Germany the latter. A moratorium postpones payment directly ; the loan bureau postpones ultimate payment indirectly and causes great inflation in addition. A modified moratorium was put into effect on bills and checks falling due after July 31, 191 4, which was extended until June 30, 19 15. The courts, however, were authorized, as in Great Britain, to extend the time for payment if the inability to pay was due to the war and if the delay did not inflict undue hardship on the creditor. As in Great Britain the courts could stay judgment, in the case of failure to pay rent, interest or Digitized by Microsoft® 264 INTERNATIONAL FINANCE AND ITS REORGANIZATION mortgages. These legal processes were made less cosdy and less involved than the usual court proceedings.* C. Operations of the Reichsbank During the War* The effect of the financial legislation enacted at the beginning of the war was soon reflected in the statements of the Reichsbank. Gold and the metallic reserves increased fairly continuously up to the middle of 1917, fluctuated slightly, reached a high level in the autumn of 191 8, and declined sharply after the armistice. The paper-money holdings of the Reichsbank increased slightly up to 1919 and very rapidly thereafter. Government paper, that is treasury bills discounted at the Reichsbank, were included with commercial bills in the weekly statement shortly after the out- break of the war, and the combined account increased continuously during the war and by very large amounts after the armistice. Before the outbreak of the war the Reichsbank notes were based on gold and commercial bills but since then have been based on Darlehnskassenscheine and treasury bills. Naturally with the increase of treasury bills and of the loan-bureau notes which were turned in to the Reichsbank, its own notes increased correspond- ingly. The increase was particularly rapid after the armistice. Corresponding to the increased holdings of treasury bills among the assets of the Reichsbank, deposit liabilities increased at a very rapid rate after the armistice. The important items in the balance sheet of the Reichsbank are as follows:' ■ Going, p. 525. Mayer, Adolph, Zur Geschichte und Theorie des Moratoriums. Schmollers Jahrbuch, 1916, xxxix, pp. 1789-1856. • Verwaltungsbericht der Reichsbank, 1914-1930. Berlin: Reichs- druckerei. Statistiches Jahrbuch, section viii. Geld und Kreditwesen, gives cumulative summary of operations. 'Paper by Bendix, Ludwig, Commissioner of Foreign Exchange of the Ministry of Commerce, The Reichsbank from the Outbreak of the War to June 30, 1920. A study submitted by Frederick Simpich of the American Mission at Berlin, July 15, 1920. Also, Raffalovich, M. A., Le Reichsbank en 1918 et 1919. Economiste Franqais, June 21, 1919, pp. 771, et seq. Also, Monthly statements in Die Bank, Berlin, Digitized by Microsoft® GERMAN CURRENCY AND CREDIT 365 SXATSUENT OF IHB ReICHSBANX (in million marks) Date Gold Paper money* Commercial bills, checks, treasury biUs Bank notes ; in circulation Deposits 1914: January 7 1204 81 1,168 2.303 804 June 30 ... . 1306 60 1,213 2,407 858 July 23 ... . I3S7 los 751 1,891 ' 944 July 31 1253 45 2,081 2,909 I.2S8 December 31 ... . 2093 880 3,937 5,046 1,757 1915: June 30 2388 514 4,918 5,840 1,799 December 31 ... . 2445 1,291 5,803 6,918 , 2,359 1916: June 30 2466 634 6,610 7,241 2,371 December 31. . . . 2520 423 9,610 8,055 4.564 191 7: June 30 24S7 452 10,962 8,699 5,693 December 31 ... . 2407 1.315 14,598 iij4<58 8,050 1918; June 30 2346 1,787 16,671 I2,SIO 9,i8i November 7 . . . . 2SSO 3.190 19,444 16.959 9,326 December 31 ... . 2262 5.270 27,416 22,188 13,280 1919: June 30 1116 9,062 33,293 29,968 13,730 December 31 ... . 1089 11,027 41,745 35.698 17,072 1920: March 31 ... . 1091 13.974 44,576 45.170 18,498 June 30 1092 17,254 50,954 53,975 23.414 December 31 ... . 1092 23,417 60,634 68,806 22,327 *Retchskassenscheine — total issue mk. 360 million, of which 30 millions on the average are kept by the Reichsbank. Darlehnskassenscheine and banknotes of four note banks (Sachsische Bank, Badensche Bank, Wiirtembergische Bank, Bayerische Notenbank) — total issue about 250 millions, of which in recent years only 3 millions on an average were kept by the Reichsbank. Digitized by Microsoft® 266 INTERNATIONAL FINANCE AND ITS REORGANIZATION '%sir.f^ § g 1 1 ^ ^ 1 g 1 § ^ Q ii ■1 1 1- L L L__H - iiyj- " i. _ _ _ __J- . ^^ . ^> *'"^v ■s^ QS" •*---. §:::::!:E;:r""'::r'"' § / ^ '-~^ ---^- j^ \----f-- J, i^ -''" "I k ;h '---. V •«ji!=.iiiiM riii'j 5 .^^ Z'-l—l- ?^ !:: = ,.^ is \ \ 2^ fc*j| 1 1 1 1 1 1 1 1 1 LU-fflTrrr :S---- - ^^=----:' iPQ \ ? jt:;::::::::::::::::::_; i^ ! ^ \ - - 3Nnr^ « :^ ~K^ " ' -^^ ^ ;!u. :::::_: :===-: 'fc "<^-lllllllll^llllllllll --^^- ---- 53/ . ^iLllll Illlllllllll ,__. sx fcj ?::::: __:::ir ii- % K- ;to - ^ >^ ^Jc -^% nn/^ v^ L L nuik Q 5 ~ ^r _ _L F^ I ""T" "^ '" " ■ ^ ^vj|iiTiiMiiii in III II ^ - . I \ -- uu. Jiij„.J_ 7 J ^^ . >(t- -T ^ cr^._.T '•^ I ferXIIIMIIIIIIIIIIlMII ^^ \\~ ~-my C ^^ f-% ■- xinr ^ •^ 5 ^ikj 4 ^3 ^ 1914 Dec. 31. 1914 Dec. 31. 191 S Deo. 31, 19x6 Dec. 31, 1917 Dec. 19x8 Aug. xs, 19x9 June 30, 1920 Total metallic reserve Imperial treasury and loan 100 roo 100 100 106 140 xia 147 1900 364 I9S 171 27S0 389 .67 I7S 910 64s 311 179 2,830 1S8 11.400 78 x8,6oo 2,020 l,xo3 76 37,400 Bills, checks and discounted 978 1,840 442 856 3,420 Reichsbank notes in circula- tion 2,080 Compared with the figures at the end of 1913, the total metallic reserve at the end of 19 17 rose 1.79 times as high as at the end of 1913, but by the middle of 1920 it had declined to 0.76 times the 1913 figure. On the other hand imperial treasury and loan bank notes by 1920 rose to 374.0 times as high, a colossal increase. The item "bills, checks and discounted treasury bills," consisting chiefly of the latter, was 34.20 times as great on June 30, 1920, as at the end of 1913. The Reichsbank notes increased 20.80 times. The extent to which government paper displaced gold and commercial bills as assets of the Reichsbank may be seen in a comparison of the ratios of the several items to the total assets at the specified dates from the end of 191 3 to the middle of 1920. The percentage of metallic reserve to total assets declined from 38.8 per cent at the end of 1913 to 1.3 per cent in the middle of 1920. On the other hand imperial treasury and loan bank notes rose from 1.2 per cent at the end of 19 13 to 21.2 per cent of total assets in the middle of 1920. The percentage of bills, checks and discounted treasury bills rose from 40.0 per cent at the end of 1913 to 71.9 per cent of total assets in the middle of 1919 and 62.5 per cent in the middle of 1920. The increase was in dis- counted treasury bills primarily. ' Baser! OP the Reichsbank returns compiled by the Federal Reserve Board from Die Bank, the Deutscher Oekonomist, and the Berliner Boersen-Courier. Federal Reserve Bulletin, October, 1919, and August, X920. Digitized by Microsoft® GERMAN CURRENCY AND CREDIT S69 Percentage of Total Assets Items Dec. 31. 1913 July 31. 1914 Dec. ■31, 1914 Dec. 1915 Dec. 31, 1916 Dec. 31, 1917 Dec. 'I918 , Aug. IS, I9I9 38.8 1.2 34-2 0.7 29-4 12. 1 2S.O 13.0 18.9 3.1 6.3 6.1 14.0 2.7 20. s 40.0 46.S S4-S S8.5 71. S 70. s 80.0 71.9 Si-7 S2.6 42.1 35.9 31. S 22.6 10.3 3.9 ,Jun» 30. 1920 Metallic reserve Treasury and loan bank notes Bills, checks and discounted treasury bills Ratio metallic reserve to notes, in circulation, per cent 1.3 21 .'a 62. s With the metallic reserve increasing slightly through 1918 and declining sharply thereafter, on the one hand, and on the other hand with rapidly increasing note liabilities, the ratio of metallic reserve to notes declined from 51.7 per cent at the end of 1913 to 2.0 per cent in the middle of 1920. If deposit liabilities be included the ratio of metallic reserve to note and deposit liabilities combined fell from 45.2 per cent on June 30 of 191 3 to 1.4 per cent on June 30, 1920. Although the loan bureau notes are not part of the liabilities of the Reichsbank they should be included among the liabilities, so as to present a true picture of the credit situation in Germany, in vi^hich event the ratio declines to 1.2 per cent. Percentage or Metal to LiABiuTrES Item 1913 1914 191S 1916 1917 1918 1919 1920 Ratio metallic reserves to notes and deposit liabilities combined, as of June 30 each year 4S.2 49-9 31.9 26.0 17. S II. 4 2.6 1.4 i. Gold Policy of the Reichsbank (a) Changes in Gold Holdings During the War — Before the war the gold in Germany was estimated at from mk. 3800 million to nik. 4400 million, of which the Reichsbank held about mk. 1357 million on July 23, 1914. The remaining amount was in circulation. The war fund, amounting to about mk. 205 million, was transferred by the government to the Reichs- bank at the beginning of the war. The gold holdings increased up to May, 1917, and declined slightly as a result of gold exports from Germany to pay for food and to maintain German credit in the neighboring neutral countries. Limited quantities were released to the German jewelry trade for export and under the Digitized by Microsoft® 270 INTERNATIONAL FINANCE AND ITS REORGANIZATION restriction that the value of the finished article be greatly in excess of the raw gold used. On October 15, 1918, the gold holdings of the Reichsbank rose to a maximum of mk. 2,662,929,- 000, as a result of incorporating in the statement the Russian gold received under the treaty of Brest-Litovsk. Since the beginning of the war, therefore, the stock of gold -at the Reichsbank increased about mk. 1305 million, net. After the armistice the gold holdings declined very rapidly, owing to payment for food supplies and to settlement of the terms of the armistice. Article 19 of this document provided for the restitution by Germany of Russian and Roumanian gold. This gold was to be delivered in trust to the Allies and held by them subject to terms of the treaty. Furthermore, cash taken from the National Bank of Belgium, as well as other specie and documents, had to be returned. By June 30, 1920, the Reichsbank had lost mk. 1600 million, of which mk. 312,740,000, taken from Soviet Russia, was transferred to Paris.^ (b) War Measures to Increase Gold Holdings — To maintain as high a ratio of gold to note and deposit liabili- ties as possible, the government engaged in a propaganda and enacted legislation to increase the gold supply. Shortly after the outbreak of the war German paper had fallen to a discount in the neighboring neutral countries. On November 23, 191 4, the Bundesrat penalized the buying and selling of gold at a premium over paper, prohibited the exportation of gold under the penalty of fine and iriiprisonment, forbade the publication of rates of foreign exchange, and required holders of safe deposit vaults to sign a statement that they did not hoard gold. Again, travelers were stopped at the frontiers and gold on their person was exchanged for notes. Privileges were extended to soldiers for collecting gold. The wealthy were required to swear that they possessed no further gold. The clergy preached and the newspapers made appeals to the public. Committees were formed in the towns to collect gold ornaments which were exchanged for notes and which were melted down.^" In exchange ' Commerce Reports, July 8, 1919. "Address of Sir Edward Holden to the stockholders of the London City and Midland Bank, January a6, 1917. See The Sta<-ist, January 27, 1917. Digitized by Microsoft® GERMAN CURRENCY AND CREDIT 27I for art objects surrendered, the Reichsbank offered engraved copies of the painting of Arthur Ksempf entitled, "I gave gold for iron — national sacrifice, 1813." German women were asked to turn in their pearls in exchange for notes. The value of these measures to increase the gold supply is doubtful. The amount of gold collected exceeded the requirements of trade. More gold was in the Reichsbank than under the pre- war system of convertible paper. The accumulation of gold as a reserve for a vast increase of inconvertible notes does strengthen however, the probability of redemption of notes. ii. Commercial Bills and Discounted Treasury Bills Before the war the Reichsbank's holding of treasury bills was kept separate from the holdings of commercial bills. Discounted treasury bills averaged about mk. 400 million from the beginning of 19 14 to the outbreak of the war. In the last week of July, 1 91 4, when war loomed up as a probability, discounting of com- mercial bills increased suddenly. After the outbreak of the war the commercial bills and treasury bills were merged on the Reichs- bank statements, but the item consisted chiefly of government paper. Bendix estimates that commercial bills declined from mk. 208 1 mil- lion in the last week of July, 191 4, to less than mk. 500 million at the end of 19 18 and rose again to about mk. 3000 million by the end of June, 1920. (a) Intermittent Increases up to the Armistice — The total volume of discounts and advances, or commercial bills and discounted treasury bills combined, fluctuated regularly around the end of March and the end of September of each year from the autumn of 1 914 to the autumn of 19 1 8, as shown in the table on page 272. The increase from about mk. 5000 million on August 31, 1914, to about mk. 24,000 million in September, 1918, was intermittent. Discounts and advances increased just before the war loans were floated in March and September of each year, but declined after the loans to a slightly lower level. These fluctuations were due to borrowing by the government in anticipation of the loans. Upon receipt of funds from the sale of bonds, the government redeemed its short-term obligations held by the Reichsbank, causing a marked Digitized by Microsoft® 278 INTERNATIONAL FINANCE AND ITS REORGANIZATION decline in this item on the balance sheet of the bank. However, as the war continued, there was a decline in the percentage and amount repaid of the treasury bills held by the Reichsbank; for instance, the decline in the spring of 1918 was only mk. 2146 million as compared with mk. 4991 million in the spring of 1917- DlSCOTJNTS AND ADVANCES (in million marks) Date Million marks Date Million marks 1914: 1918: June 30 1,28s March 30 ... . 16,034 My 31 2,283 April 30. . . . 13,888 August 31 4,85s September 30 ... . 23.830 September 30 4,786 October 31 ... . 20,679 October 31 2,809 1919: 1915: March 31 ... . 30.187 March 31 6,877 April 30 3^,553 April 30 3,807 September 30 ... . 33.859 September 30 7,484 October 31 ... . 34.016 October 30 4,22s 1920: 1916: March 31 44,S76 March 31 8,124 June 30 50,954 April 29 5,138 September 15 ... . 49,720 September 30 10,769 October 31 7,891 1917: March 31 13,606 April 30 8,71s September 29 15.633 October 23 ",553 (b) Great Increases After the Armistice — After the armistice the increase was no longer intermittent; it was continuous. From November, 1918, until June, 1920, the floating debt of the Empire rose from mk. 45,000 million to mk. 117,000 million, and the Reichsbank holdings of commercial bills and treasury bills in the same period rose from mk. 21,000 million to about mk. 51,000 million. This huge increase in ij^ years is in striking contrast to the increase in the previous four years, from about mk. 5000 million on August 31, 191 4, to mk. 21,000 million on October 31, 1918. The former increase was twice Digitized by Microsoft® GERMAN CURRENCY AND CREDIT 273 as great as the latter. The reason for this continuous Increase in the floating debt and in the correspondingly continuous increase in the Reichsbank holdings of treasury bills and of commercial bills was that German government credit had broken down and it was therefore impossible to float a long-time loan, which would partly refund the floating debt. Then again after the armistice the neutral governments refused to extend even short-term credit to Germany. The expenses of demobilization were met by means of treasury bills, and these were not entirely sold to the public but in large part discounted at the Reichsbank. In other words, the Reichsbank carried the floating debt of Germany after the armistice.^^ iii. Note Issues (a) Increases by Years — The Reichsbank notes in circulation increased continuously after the beginning of the war, except to the extent that there was a very slight decline during the periods of subscriptions to loans. The notes in circulation on July 31, 19 14, amounted to mk. 2909 million, and after a fairly continuous rise amounted on October 31, 1918, to mk. 16,661 million, an increase of about mk. 13,000 million. The increase of notes before the armistice was due to the flooding of the invaded territories with German marks. For instance, in 191 7 the ruble in Poland was superseded by the Polish mark, which was made the equivalent of the German mark and which bore the guaranty of the German government of conversion into German marks. In addition to her own notes Germany guaranteed the redemption of mk. 760 million of Loan Office notes circulated by the Loan Office of the East, as well as mk. 800 million of Polish Loan Office notes and mk. 400 million of notes issued in the Ukraine as well as the mark notes issued in the French and Belgian territories invaded. The Belgian mark notes amounting to mk. 5500 million were refunded by German bonds payable in 20 years and bearing 5 per cent interest beginning May, 1 92 1." "The 1918 report of the Reichsbank. See also Federal Reserve Bul- letin, May, 1919. " Commerce Reports, February a, 1920. Digitized by Microsoft® 274 INTERNATIONAL FINANCE AND ITS REORGANIZATION Owing to the inability to raise funds through loans after the armistice, notes in circulation rose by leaps and bounds to a level of mk. 53,975 million on June 30, 1920, an increase in that time of mk. 37,000 million. The rate of increase during 1915 was about 37 per cent; during 19 16, 17 per cent; during 19 17, 42 per cent; during 1918, 106 per cent; during 1919, 61 per cent and during the first half of 1920 51 per cent. The increase after June, 1920, was at a growing rate, the increase during July and August being about mk. 5000 million. The total notes of all kinds in circulation on August 31, 1920, amounted to mk. 72,000 million, of which mk. 58,000 million were Reichsbank notes. By the end of September, 1921, the note circulation rose to mk. 86,384 million. Concurrent with the increase of paper money the gold reserves declined from mk. 2550 million on November 7, 191 8 to mL 1092 million on June 30, 1920, because of payments for fooH imports. (b) Analysis of Total Notes in Circulation—' The total note circulation on August 31, 1920, amounted to over mk. 72,000 million, of which the largest part consisted of Reichsbank notes, a substantial portion of Loan Bureau notes, and relatively small sums of treasury notes and private bank notes. The distribution is shown herewith: Analysis of Note Circdiation (in million marks) Amount Per cent Reichsbank notes 58,401 315 13,266 240 80.9 0.4 18.4 0-3 Government treasury notes (Reichskassenscheine) Loan bureau notes {Darlehnskassenscheine) Total 72,222 However not all of this paper money is in actual circulation in Germany The amount held in Belgium is about mk. 6000 million and in France about mk. 4000 million, and other large amounts were bought and held on speculative account in the neutral countries of Europe as well as in North and South America. Bendix esti- mates that mk. 20,000 million are held outside of Germany and Digitized by Microsoft® GERMAN CUKRENCY AND CREDIT 275 that another mk. 9000 million are hoarded by the population in the attempt to evade the drastic taxes. (c) The Causes of the Increase in Note Circulation — A prime cause for the increase in note circulation >was the policy of financing the war by loans. Other less fundamental causes appeared from time to time. During the month preceding the armistice, when the military collapse of Germany was impend- ing, the public became panicky and entertained fears as to the solvency of the banks and even as to the possibility of a moratorium. Therefore, they withdrew their deposits from commercial and savings banks and hoarded the paper. In the month from Septem- ber 24 to October 23, 19 18, the total note circulation increased by mk. 2652 million as against one-quarter that figure in the corresponding period in 1917. Another cause of increases in notes issued which became effective in 19 19 was legislation requiring banks to reveal their clients' holdings of stock and bonds. This measure caused heavy selling of securities and the hoarding of paper money. Again the levy on capital was an incentive to wealthy people to convert their taxable goods into a form that was less liable to detection. Then again the so-called "hole in the west," the occupied territory, was not controlled by the German customhouses and the large volume of imports paid for in German paper money caused an artificial shortage in Germany proper. During 191 9 and 1920 notes were issued to pay for reparation in France and for reimbursement of owners of property taken by Germany. Low discount rates made inflation possible. (d) Measures for Relieving the Lack of Currency ^^ — I. Note issues by towns and chambers of commerce — When the shortage in currency became acute the local communities undertook to supply the deficiency. For instance Hamburg and many other German towns issued 50-pfennig notes.^'* By the autumn of 1917 over 50 municipalities had availed themselves of the right to issue emergency paper money. These issues became very extensive and the imperial authorities attempted to check the practice by requiring that against any such issue a balance of equal "Address of Herr Havenstein, President of the Reichsbank, published in the Frankfurter Zeitung, October 31, 1918. " London Economist, April 28, 1917. Digitized by Microsoft® 376 INTERNATIONAL PINANCE AND ITS REORGANIZATION amount must be kept in the Reichsbank as security for redemp- tion.i" About the time of the armistice, the shortage became so acute that the municipalities issued emergency notes; for instance the town of Mannheim issued mk. lo million and Berlin mk. 47 million.^" The difficulties of securing wide circulation were over- come by municipal regulations, for example the Frankfort street railway agreed to accept the emergency money not only of Frank- fort but also of Hanau, Hoechst, Offenbach, and the Hanau district.^^ The emergency currency issued in the last quarter of 191 8 was wholly withdrawn from circulation in the early part of 1919, and was replaced by aluminum pfennig pieces of the empire. To decrease the volume of notes outstanding the Reichs- bank encouraged payment by check, by developing the system of Giro Verkehr and by increasing the number of clearing houses.^* 2. The use of interest coupons — ^Although the towns were asked by the imperial government to prepare emergency notes in the autumn of 19 18 the shortage remained unrelieved. In order to create immediately an additional medium of circulation, the interest coupons on the war loan which were due on January 2, 1 919, were declared by the Bundesrat to be legal tender up to the due date. By this means mk. 600 million were added to the cir- culation. 3. Private printing establishments utilized — ^When all the measures adopted were found to be inadequate, the Reichsbank turned to ordinary printing establishments to print new bank notes of mk. 50 which the official printing plant was unable to turn out in sufficient quantity.^^ (e) Loan Bureau Notes, Darlehnskassenscheine ^'^ — . The increase in the Reichsbank notes alone does not indicate '"London Economist, September 23, 1917. For' illustrations of emergency coinage and notes see Benjamin White, Currency-of the Great War. London: Waterlow and Sons, Ltd., 1921. "Koelnische Zeitung, October 22, 1918. Wirtschaftszeitung der Zentralraaechte, November i, 1918. " Frankfurter Zeitung, November 24, 1918. "'Reichsbank report for 1919. See also Federal Reserve Bulletin, June, 1920. "" Norddeutche Allgemeine ^eitung, October 20, 1918. ""Lammers, Die Tatigkeit der Darlehnskassen. Die Bank, January, 1915, pp. 32-37. Digitized by Microsoft® GERMAN CUERENCY AND CREDIT 277 the extent of the inflation of paper money. The loan bureaus were authorized to issue notes not to exceed mk. 1500 million under the original act, but this maximum could be raised by order of the Bundesrat. The volume of notes issued increased to mk. 12,911 million by November 7, 1918, just before the armistice. In contrast to this increase during a period of four years, the issue of loan bureau notes in the 19 months following the armistice increased by mk. 18,036 million. The additional notes issued during 1919 amounted to mk. 9269 million and during the first half year of 1920 the additional notes were mk. 6052 million. Under the war legislation the Reichsbank was authorized to substitute the Darlehnskassenscheine for gold in its cash reserve. The notes of the loan bureau were exchanged by the Reichsbank for its own notes, the latter then retained the loan bureau notes as a "cash" cover and thereupon issued three times the amount in its own notes. For this reason the loan bureau notes in circula- tion were always less than the total amount issued. As additional Reichsbank notes were issued more Darlehnskassenscheine were withdrawn from circulation and placed in the Reichsbank to in- crease the cash reserve. On November 7, 1918, only mk. 9518 mil- lion of the loan bureau notes were outstanding, although mk. 12,911 million had been issued. The difference, mk. 3393 million, were retained by the Reichsbank to help support an increase of Reichs- bank notes in circulation of mk. 14,050 million since August, 1914. From November 7, 1918, to June 30, 1920, the Dar- lehnskassenscheine in circulation increased mk. 41 15 million while the balance of the amount issued, 13,921 million, had been turned over to the Reichsbank to support an increase in the Reichsbank's note circulation of mk. 37,016 million. A particularly interesting aspect of the workings of this device to increase the note issue was the experience during the first half year of 1 920. During this period the Reichsbank notes in circulation increased mk. 18,277 million and not only the total loan bureau notes issued, about mk. 6052 million, were turned over to the Reichsbank, but in addition mk. 148 million of loan bureau notes were withdrawn from circulation for this purpose. In brief, the issue of Darlehnskassen- scheine was the means of increasing by threefold the additional Reichsbank note circulation. The following table shows the total loan bureau notes issued and in circulation: Digitized by Microsoft® 278 INTERNATIONAL FINANCE AND ITS REORGANIZATION Loan Bureau Notes " (in iniUion marks) Date Total issue Circula- tion * Date Total issue Circula- tion 1914: 1918: . anuary 7.... .... June 30... 9,474 7,582 ■'une 30.'... November 7 . . . 12,911 9,518 ;uly 23.... December 31 . . . 15,626 10,109 . uly 31 . . . . December 31 ... . 1,317 446 1919: - June 30. . . 20,889 12,027 1915: December 31 . . . 24,89s 13,781 June 30. . . . 1,258 70s December 31 2.347 972 1920: March 31 . . . 27,787 13,731 1916: Jime 23... 29,857 13,285 June 30. . . . 2.033 1.316 June 30. . . 30,947 13,633 December 3 1 3.408 2,873 1917: June 3°- ■ • ■ 5,076 4,521 December 3 1 7,689 6,265 'Amount held by the Reichsbank deducted, (f) Imperial Treasury Notes, Reichskassenscheine — In addition to the notes of the Reichsbank and of the loan bureaus the total note circulation included mk. 360 million of imperial treasury notes, the origin and increase of which were referred to above. Furthermore the four private banks that retained the privilege of note issue had about mk. 352 million in circula- tion. Finally, the municipalities and communities issued about mk. 200 million of emergency paper, particularly in small denomi- nations. IV. Deposits The statements of the Reichsbank since the beginning of the war, shown above, present a clear picture of the increase in deposits. Up to the time of the signing of the armistice deposits increased mk. 8068 million above the amount outstanding on July 31, 1914. This is approximately a rate of increase of mk. 2000 million a year. In the V/z years approximately between the date of the "From the Bendix memorandum. Digitized by Microsoft® GERMAN CUEEENCY AND CREDIT 279 armistice and June 30, 1920, deposits increased mk. 14,088 million, a growth at the rate of about mk. 9000 million a year. The increase of course was due to the fact that the government redis- counted large quantities of Treasury bills at the Reichsbank. D. Effects of Inflation There are many indicators of the effects of inflation: A premium on gold at home, or if this is illegal the disappearance of hard money, the rise of foreign exchange rates, a rise in prices, and an increase of profits of industry and banks. i. Depreciation of Currency In the early stages of the war a premium on gold was offered, but was made illegal by war legislation.^^ However, the working out of economic laws was inevitable. The court records show prosecutions for trading in gold. In fact, the prohibition on the free exchange of paper and gold caused greater depreciation of German paper money within Germany than in the neighboring neutral countries. That is in the spring of 1918, i gold mark was equivalent to 3 paper marks in Germany, but to only 2 paper marks abroad. The prohibition on offering or accepting a premium on gold within Germany resulted in the exportation of gold in order to obtain the premium abroad. The prohibition on the free exchange of paper and gold likewise resulted in the disappearance of gold and silver in circulation and in the need for the substitu- tion by iron, zinc and aluminum coins. Eventually the discount on paper money was officially recog- nized; the government decreed in November, 19 19, that 100 gold marks were to be the equivalent of 475 paper marks in the pay- ment of import duties, a discount of approximately 79 per cent on paper. The Reichsbank likewise officially recognized the depreciation of paper in terms of silver, the ratio being i mark silver to 8 marks of paper. ^^* Of course the relatively slight rise in the price of silver affected the ratio. Again, the German Minister of Public Works in the summer of 191 9 fixed prices at which foreign gold coins should be accepted by the German railways. "^ Going, p. 543. 22»Vorwarts, Feb. 13, X930. Digitized by Microsoft® 280 INTERNATIONAL FINANCE AND ITS REORGANIZATION The British sovereign which at parity was equal to 20.43 marks was fixed at 51. 05 marlcs; 10 Dutch florins, which at parity were equal to 16.88 marks, were fixed at 42.15 marks; and the American dollar, at parity 4.2 marks, was fixed at 10.45 marks. The deprecia- tion of gold was evident early in the war, particularly in trade with the neutrals. Large shipments which were sold on a gold basis were held up on the German frontier by the Dutch authori- ties because paper money was tendered in payment.^^ The prohibition on the free exchange of depreciated paper for gold led to a peculiar phenomenon during the war, particularly in the spring of 19 18. In the neutral countries, American paper money was bought up by Germany at rates more favorable than the equivalent of the American dollar exchange in the neutral markets. ii. Rise in Prices^ (a) Course of Rise — Until 1920 there was available neither an oflGcial nor a standard index of commodity prices in Germany. But the course of prices during the war can be obtained from the "standard food budget" compiled by Calwer from the average of official maximum prices for about 200 localities and based on the peace-time ration of the seamen of the German navy, but calculated for a family of four persons. 1913. marks 1914, marks 1915, marks 1916, marks 1917. marks 1918, marks 1919, marks AprU. . . August. 25.61 24.96 26.41 34-41 39' 13 SI. 78 54.81 S3 53 54-67 I S7-I3 S9-43 69.6s 8S-4S Relative figures based on April, 1913, as 100 April. . . August. 97 103 134 152 202 209 214 213 223 232 273 334 '' New York Times, August 15, 1917. "Englander, Oskar, Fragen des Preises, Schmollers Jahrbuch, 1919, xHii, pp. 933-981, and 1395-1458, A study of price theories. Statistisches Jahrbuch fur das Deutsche Reich, section ix, Preise, gives record of prices for ten years for a great number of commodities. Vierteljahreshefte zur StatistiU desDeutschen Reichs, gives the monthly average prices of important commodities. Digitized by Microsoft® GERMAN CURRENCY AND CREDIT 281 These ofKcial maximum prices, however, do not represent the entire rise. There was illicit trading at higher prices and uncon- trolled prices also entered into the cost of living. Furthermore) after 1919, during the period of vast increases in the note circu- lation outstanding, prices rose more rapidly than during the war. Until August, 1918, prices had risen to only 2.3 times the pre- war level, but in the following year the increase was almost as great as in the entire four years preceding.^^ The rise in the price of raw materials was much more rapid after the armistice and in response to the inflation of the currency. The figures in marks per ton of hematite iron ore were as follows.^' 1914 Nov. I, 1919 Dec. I, 1919 Jan. I, 1920 Feb. I, 1920 Actual price 79 -SO 100 S73-SO 72s 1171-50 2470 1718.50 2160 2227.50 2800 Relative The price of the best Ruhr coal (nut size) in marks per ton like- wise rose more rapidly during the period of great increase of circulation, as follows: 1914 Oct., 1919 Dec, 1919 Jan., 1920 Feb., 1920 Actual price 13 100 86 66s 97 745 118 910 160 Relative 1230 (b) Extent of the Rise — From 19 14 to 1920 the average increase of living expenses was over sixteenfold.^^ The item showing the largest increase was eggs, the price of which in 1920 was 32 times the 1914 price. The smallest increase was in house rents which rose only 20 per cent, owing to the maximum allowance set by law. Carfares also ^From the Deutscher Reichsanzeiger (Berlin), December 19, 1919. Reprinted in the U. S. Labor Review, April, 1920. ™ Berlin correspondence, London Economist, February 14, 1930. For additional information on prices see British Board of Trade Journal, October 3, 1918, and Commerce Reports, December 30, 1918. " Compiled by the American Association of Commerce and Trade in Berlin. See also the Bavarian Statistical Year Book for 1919, abstracted in the Monthly Labor Review, April, 1930. Digitized by Microsoft® 282 INTERNATIONAL FINANCE AND ITS REORGANIZATION showed a moderate increase of only 600 per cent. The iniported commodities, such as cloth and clothing, shoes and meat, showed the largest increase. The table is given herewith : Commodities 1914, Marks 1920, Marks Ratio 1920 to 1914 prices, in per cent Food: Potatoes, lolb Butter, per lb Eggs, per doz Meat per lb. (average between pork and beef) Common vegetables (average between various kinds of vegetables) Bread (i-lb. loaf) Coal (brickets) per cwt Clothing: Men's suits, ready-made Men's suits, tailor-made Men's shoes Cloth for women's clothes, per meter . . . Cloth for women's clothes, muslin, per meter Carfare Rent: Apartment of five rooms per month Amusements: Theater Moving pictures Average of living expenses 0.30 1-2S 0.65 1. 00 0.25 0.4s 1. 00 60.00 80.00 12.50 7-So 2.50 o.io 125.00 ISO 0.50 4.00 17.00 21.00 24.00 4.00 450 23 SO 1300.00 2000.00 300.00 175.00 39.00 0.70 150.00 8.00 2.00 1333 1360 3230 2400 1600 1000 2350 2100 2500 2500 2330 1560 700 S33 400 1620 The increase during 1920, according to the index number of the Frankfurter Zeitung, was as follows: January 100 March 147 June 149 September 144 December 156 (c) The Lag in Wages and Cost-of-Living Subsidies — The rise in the cost of living was followed naturally by a rise in wages. However, these lagged far behind. For instance the wages of a cabinetmaker rose from about mk. 43 per week in Digitized by Microsoft® GERMAN CURRENCY AND CREDIT 283 1913 to mk. 336 per week in 1920, or about 7.8 times. In the several trades, the wages of unskilled labor increased to a greater extent than did those of the artisan, whereas clerical help increased least of all. The table for a few trades is given herewith.^* Tradesman 19131 9-hour day 1920, 8-hour day Ratio 1920 to to 1913 Cabinetmaker Plumber Electrician Typesetter Bricklayer Unskiller labor Conductor, street railway Laborer Clerk, bookkeeper, stenographer 43.20 40.50 39- 15 37-0° 44.28 30.78 30.00 20.50 40.00 336 220 204 230 216 206 218 206 190 7.8 5-4 S-2 6.2 4-9 6.7 7-3 10. o 4.8 The great gap between the rise in commodity prices and the rise in wages caused a hardship on the poor. An investigation conducted by the German Bureau of Labor Statistics ^^ shows that the deficits in family budgets, which at first had afifected only the poorer classes, later on also affected the moderately well-to-do, whose incomes were relatively reduced by the rise in prices result- ing from inflation. The average monthly deficit per person employed was mk. 20.30 in the families of laborers and mk. 49.33 in the families of government clerks. To meet these deficits the government authorized the granting of subsidies. In 19 19 mk. 3000 million ^^ were devoted to food subsidies. This was equivalent to 50 marks per annum per head of the population. How pitifully inadequate this must have been can be seen by comparing this subsidy of mk. 50 per head per annum with the actual budget deficit of mk. 49 per worker per month. The policy of subsidizing must fail because out of the total increase in note circulation, which causes a rise in prices, only a small fraction can be devoted to the granting of subsidies, whose object is to overcome the entire rise in so far as it affects the poor. °' American Association of Commerce and Trade in Berlin, ibid. " Statistisches Reichsamt, Abteilung fur Arbeiterstatistik. Beitrage zur Kenntnis der Lebenshaltung im vierten Kriegsjahre (ai. Sonderheft zum Reichs-Arbeitsblatt). Berlin, 1919. Reprinted in U. S. Labor Review, January, 1920. "Berlin correspondence, Journal of Commerce, April la, 1920. Digitized by Microsoft® 284 INTERNATIONAl FINANCE AND ITS REORGANIZATION lii. The Increase of Deposits and Profits a. The Reichsbank turnover and profits — Perhaps the most direct effect of inflation is to be noted in the turnover of the Reichs- bank. In 1913 this figure amounted to mk. 422 billion, in 1916 it reached 1000 billion, in 191 7 it exceeded 13 13 billion, and in 191 8 the total turnover of the Reichsbank vs^as 3343 billion, an increase to almost ninefold the 1913 figurre. Correspondingly the total gross profits likewise increased from 133 million marks in I9i4> to 273 million in 1915, 326 million in 1916, 365 million in 1917, and 814 million in 191 8. The largest part of this profit consisted of profits on bills, checks and imperial government bonds.'*^ b. The effect on the private banks — The effects of inflation are evident from a study of the balance sheets of the eight leading banks of Germany. Consolidated Statement or Eight '" Leading Banks of Germany, as of December 31 op Each Year (in million marks) Items Assets: Cash, coupons, foreign gold, and balance with banlcs of issue -and clearing Bills, including treasury bills Due from banKs Stock exchange loans and advances . Advances on merchandise Securities owned Syndicate ^participations Participations in oanks and banking firms Debits in current account Sundry assets Total Liabilities Capital paid in Surplus and reserve Credits in current account Acceptances and checks Sundiy liabilities Total 1913 1916 1917 1918 1919 3SS 1766 308 794 Sio 402 336 272 2853 147 577 1819 337 741 I7S 437 337 357 3232 181 735 2493 410 894 210 443 308 360 3313 187 863 3.961 63s 1,334 262 441 267 351 3,394 192 7,152 1.346 1,828 315 238 354 4.536 2x1 1.423 11.281 1,073 1,986 115 791 246 368 4,694 223 2.S40 23.097 3,574 1,605 851 587 342 359 9,374 233 lios 360 4804 1309 165 8193 1255 457 5321 1016 144 9354 1255 457 6856 612 174 1,255 46r 9.396 38s 203 1,350 54° 15,210 397 326 1,350 547 19.696 359 348 42,362 1,350 553 39,140 9S8 361 7743 8193 9354 11,700 17,723 32,300 42,363 "Deutscher Allgemeine Zeitung, March 31, 1919, reprinted in Com- merce Reports, July 8, 1919. " Federal Reserve Bulletin, October, 1920. The banks are Deutsche Bank, Disconto-Gesellschaft in Berlin, Dresdner Bank, Bank fiir Handel und Industrie (Darmstadter Bank), Commerz- und Disconto-Bank, Berliner Handelsgesellschaft, Nationalbank fiir Deutschland and Mittel- deutsche Creditbank. Digitized by Microsoft® GERMAN CURKENCY AND CREDIT 285 A comparison of the consolidated balance sheets for these eight banks as of the end of the years 1913 to 1919 shows an increase of cash of sevenfold, an increase of bills, including treasury bills, of over thirteenfold, an increase of the item "Due from banks" of about twelvefold, and lesser increases in the items, "Debits in cur- rent account," "Credits in current account," and "Total assets or liabilities." The capital increases were slight, about 20 per cent. Advances on merchandise among the debits, and acceptances and checks among the credits, decreased through 1918, as was to be expected, owing to the displacement of commercial credit.by govern- ment financing. However, in 1919 both these items showed a marked increase. The foregoing table gives the items in million marks. The changes in the statements of these banks become more evident if the relative figures based on 1 91 3 returns as 100 are given: Relative Figures in Consolidated Statement oe Eight Leading Banks (1913 figures = 100) ,^ Items Cash Bills, including treasury bills Due from banks Debits in current amount . . . Capital paid in Credits in current account. . , Acceptances and checks Total assets or liabilities I9I3 I9I4 191S 1916 1917 1918 100 163 208 243 3S6 401 100 103 141 224 405 639 100 109 133 206 437 34» 100 113 116 119 IS9 it.S 100 "3 "3 "3 122 122 100 III 142 iQS 31b 410 100 7« 47 29 30 27 100 106 121 151 •229 287 I9I9 719 1309 1 160 325 122 81S 73 547 As in the Reichsbank statement it is difficult to trace the extent to which government paper displaced commercial paper among the assets of the private banks because they too merged commercial bills with treasury bills. Since the combined item consisted chiefly of treasury bills, the ratio of bills to total assets would indicate the extent to which government paper became the chief resource of the banks. Item 1913 1914 191S 1916 1917 1918 1919 Percentage of bills to total assets at end of year . . . 22.8 22.2 26.7 33-9 40.3 SO. 3 S6.6 Digitized by Microsoft® 286 INTERNATIONAL FINANCE AND ITS REORGANIZATION c. Increase of savings banks deposits — During the war, with the ever-increasing flood of paper money, and with the diminishing supplies of commodities available for purchase (and most of these rationed and sold at fixed prices) the deposits of the savings banks increased by leaps and bounds. The combined German savings banks showed net increases in deposits of mk. 1121 million in 191 4, 2541 million in 1915, 2660 million in 1916, and 4160 million in 1917, or taking the 1914 returns as a basis of 100 the deposits in 1915 were 2.26 times as great, in 191 6 2.37 times and in 19 17 3.70 times as great as in 1914. In Berlin many new branches of the savings banks had to be opened to accommodate the increasing number of depositors. Dur- ing the year 1918 the total deposits in 48 of the leading savings banks, showed an increase of about 34 per cent, although the number of depositors had increased only 10 per cent.^' d. Increased profits in industry — ^Along with the rise in prices, profits in industry increased very largely. True, they were paper profits and in contrast with the prices of imported raw materials, the fictitious character of paper profits became apparent. For instance the General Electric Co. of Germany, whose paid-up capital stock was mk. 200 million, had to purchase copper amount- ing to mk. 2 million daily, so that a lOO-day supply of copper was equivalent to the total capitalization of the company. That is, a sum supposed to be sufficient to build the entire plant could hardly purchase a three-months' supply of one raw material.** Furthermore, the large increases in capitalization which were necessary to maintain adequate working capital under rising prices, worked an injustice to the original shareholders who paid in gold marks. However, this difficulty was circumvented by offering to the existing shareholders the right to subscribe to new stock. The rise in profits was reflected in the rise in dividends. The Phoenix Mining & Smelting Works raised its dividend from 10 per cent in 1913 to 20 per cent in 1918. The Deutsch-Luxem- bourg Mining and Smelting Co., which paid no dividend in 19x3, paid 10 per cent in 1918. The United Koenigs & Laura Smelting Co. raised its dividend from 4 per cent in 191 3 to 12 per cent in "Sozial Praxis, January 17, 1918; Die Konjunktur, February 21, 1918. Report on German savings banks in Die Sparkasse, reprinted in Com- merce Reports, April 15, 1919. ** Geneva correspondence. New York Evening Post, January 17, 1920. Digitized by Microsoft® GERMAN CURRENCY AND CREDIT 287 1 91 8. The Mannesmann Tubing Works dividend rose from 7j4 per cent in 1913 to 18 per cent in 1918, and the Gas Motor Manu- facturing Co. from 5 per cent in 191 3 to 10 per cent in 1918.'° E. The Outlook It is difficult to speak definitely of Germany's financial outlook in view of the many uncertain factors that aflect it. A iew things, however, may be said fairly certainly. The recommendations of the Cunliffe Committee in Great Britain certainly cannot apply to Germany. Whereas gradual deflation is practicable for Great Britain and perhaps even for France and for Belgium, in Germany something less time-consuming and more drastic may have to be put into efEect. i. Gradual Deflation Not Feasible^^ In view of the fact that America is a free gold market, the dollar may be taken as the equivalent of gold and therefore ex- change rates on the United States reflect approximately the degree of depreciation of the European currencies. Germany, like most of the countries of central Europe, is suffering from a depreciation of over 90 per cent. The demand exchange rates on November 11, 1920, were as follows : Country Germany Finland Poland Austria Czecho-Slovakia Hungary Jugoslavia Roumania Servia Parity. Cents 23 8 23 8 23 8 20 3 20 3 20 3 20 3 19 3 19 3 Demand rate. Cents 113 2.19 0.24 0.28 1. 01 0.18 0.70 1-45 2.74 " Wirtschaftsdienst, December 13, 1918. " Schaefer, Karl U., Die legale Devaluation, Schmollers Jahrbuch, 1919, xliii, pp. 1458-1475, a study of pros and cons of deflation and re- valuation. Digitized by Microsoft® 288 INTERNATIONAL UNANCE AND ITS REORGANIZATION These weak countries, of which Germany is the most impor- tant, cannot deflate their currency and hope to bring it back to parity. Of themselves and without a vigorous fiscal policy these currencies will not become stable. Even with a vigorous fiscal policy and at the rate of economic progress, before the war, deflation from the present levels would take more than a generation. With its vast untouched resources and its huge tides of immigra- tion after the Civil War the United States requited 15 years to deflate a paper currency which at its lowest (in 1864), was quoted at 38.7 per cent of the value of gold, but which rapidly rose in 186s to 46.3 and in 1866 to 66.0 at the "low" quotation." The weak countries of Europe listed above show a far greater depreciation of paper with respect to gold, and worse still instead of showing an improvement after the war as the United States did in 1865 and 1866, these countries have further inflated their currency and suffered further declines in their exchanges. In none of these countries is it likely that the currency will recover its pre- war parity within a generation, if at all. Furthermore, whatever injustice and suffering inflation has wrought is a matter of the past. A process of deflation would mean a long period of declining prices, of severe taxes, of repressed industry, and of general stagnation. Finally, the foreign holdings of a large part of the floating debt of most of these countries will tend to repress any rise in the price of paper money in terms of gold. As paper money increases in value, and correspondingly as the exchanges improve, the foreign holders will sell for profit and depress the exchanges. August Mueller, former Minister of Eco- nomics, is the authority for the statement that Germany's debt of about mk. 230 billion is probably redeemable at the present low* value of the mark, but never if the mark recovers even half its former value.^* Deflation will mean the enriching of the foreign speculator at the expense of the recuperative possibilities of the in- dustries. ii. The Position Under Depreciated Paper The attempt to dispense with gold as a regulator of commercial and financial values is infeasible, if not impossible. The absence of " Mitchell, Sound Currency, vol. 3, No. 17. "Berliner Abendblatt, April 34., 1920. Digitized by Microsoft® GERMAN CXJERENCY AND CREDIT 289 gold in international settlements of Germany with other countries would mean wide fluctuations of exchanges, with all the unsettling effects on industry. It would also discourage loans to Germany, even of short maturity, because of the likelihood of violent changes between the dates of the loan and the date of its repayment, and finally, without gold as the governor and regulator of the volume of paper money, the temptation to overissue is fatal. Few govern- ments have been able to resist it.^' iii. Internal Measures as Remedies The first essential for a stabilization of Germany's finances, is the refunding by means of foreign loans of the floating debt held outside of Germany. Until this is done, the exchange rate of Germany will be depressed below its inherent value, because of the continuous selling pressure exerted on the mark when it rises in response to an improvement in the finances of Germany. The inducement to the present holders of German currency and of German short-term bills to fund their holdings is a likelihood of a rise in German exchange and a profit upon the redemption of the long-term loan. ' However, international trade requires that gold act as a correc- tive and as a stabilizer. Fiat money may do in internal commerce but international commerce requires a medium current everywhere, and gold alone is such a medium. Yet the chief requirement for the restoration of gold as a governor is a revaluation of the mark. What effect this may have is evident from the analogous situation in France 100 years ago. When the mandats, which had replaced the assignats, were given currency at their quoted gold value by the decree of the French National Assembly on July 16, 1796, there was a noticeable improvement in the financial condition of the country. Specie, which had been in hiding, immediately reappeared in circulation. Goods and commodities being very cheap were exported in great quantities, the exchanges immediately turned in favor of France, and within a short time the metallic currency was restored.*" The adoption of a new parity would mean a capital tax on the "Kann, Herbert, Gold oder Papier, Europaeische Staats-und-Wirt- Ichafts Zeitung, September, 1917. "MacLeod, xhid, ._ Digitized by Microsoft® 290 INTERNATIONAL FINANCE AND ITS REORGANIZATION holders of securities and of property bought at pre-war gold values, and while it may be unjust it is the shortest road to the restoration of financial health. iv. Allies' Policies as Remedies In addition to the factors within her control the restoration of Germany depends on many conditions beyond her control, such as the recognition of the economic difficulties in the peace treaty, the amelioration of the terms of peace to enable Germany to pay the indemnity, the extension of credits to Germany by the neutral countries producing raw materials secured perhaps by the German properties seized by the enemy during the war or else by a lien prior to all other claims, including reparation and indemnity claims, much the same as receiyers' certificates of a corporation, and finally the restoration of trade with Russia and the reestablishment of the economic unity which prevailed in Europe before the war. These are but a few of the economic elements which condition the future of Germany, and make a categorical prediction as to her future futile. Digitized by Microsoft® Part Three FOREIGN EXCHANGE CHAPTER IX PRINCIPLES AND PRACTICE IN THE WORLD WAR^ The presentation of the movement of the foreign exchanges in the United States, during and after the war, is, for several rea- sons, an essential part of a study in international finance. The exchange rates on the United States reflect the financial condition of the European countries, v\?hich constitutes the object of our study. Furthermore, the stabilization of the Allied ex- changes during the war was made possible by the vast loans of the United States government to the Allies. Finally, because the • United States has been a free gold market except during the period of hostilities, the exchanges quoted in New York are at their gold value. A. The Theory of Foreign Exchange i. Determinants of Exchange Rates Exchange rates are determined by the supply of and demand for drafts between countries. If the merchants of one country have an oversupply of bills drawn on another country, the exchange rates of the second country will decline. Before the nineteenth century, such an oversupply arose mainly from an excess of commodity ex- ports. The chief means of liquidating bills in excess of demands of trade was by the shipment of gold. When gold and merchandise were the chief determinants of exchange rates, exports were en- couraged as a means of increasing the gold supply of a country. Under the mercantile system, an excess of commodity exports was ' See Le Probleme des Changes chez les Belligerants, Jlapport Generale, Chainbre, 1919, No. £158, part of the report on the budget of Fiance, 291 Digitized by Microsoft® 292 INTERNATIONAL FINANCE AND ITS REORGANIZATION regarded as an index of prosperity. In the relatively restricted economic life of that period, an excess of exports was regarded as a favorable balance of trade. As life has become more mobile, the traffic between nations has come to include categories other than goods. Although the move- ment of merchandise constitutes the chief source of supply of bills, other important factors are the flow of capital between countries and the performance of services. In modern times the mercantile theory is discarded. The modern view of international trade is, that exports constitute the surplus of goods which it is economical to produce and to exchange for goods which can be produced more cheaply by other countries. There are more means than one for settling an excess of exports or of imports. A nice balance of mer- chandise imports and exports is no longer regarded as being so im- portant as the mercantilists thought. Some countries have a continuous excess of imports, which is balanced by interest due on foreign loans, as in England, or by borrowings abroad, as in some of the Latin American countries before the war. On the other hand, some countries have a con- tinuous excess of exports, which is applied to the settlement of in- terest owed or of loans maturing. Other factors comprised in the international balance of debits and credits are the flow of capital arising out of expenditures of travelers, for pleasure, study, or busi- ness, out of remittances and gifts between immigrants and their friends and families. Foreign drafts also arise from the rendering of international services, such as shipping, insurance, banking and brokerage. Whatever the source of the debt, drafts arising there- from have the same effect as drafts based on movement of com- modities. (a) Commodity Movements — In general the older countries of Europe, such as England, France, Germany, and Switzerland, have an excess of imports and the younger countries such as Russia, the United States, British India, and Argentina have an excess of exports. During the early history of a developing country, while it borrows money abroad, it has an excess of imports. Subsequently, it develops an excess of exports to pay the interest and principal on its foreign loans. Finally, when it has attained industrial maturity and liquidated its indebtedness abroad, it may invest its surplus funds. As the Digitized by Microsoft® PEINCIPLES AKD PRACTICE IN THE WORLD WAR 293 Interest due to it accumulates, it develops an excess of imports. Examples of this development may be found in the statistics of international trade prior to the war or in the industrial history of the older countries. (b) The Flow of Capital— The movement of funds between the nations is the second principal factor affecting exchange rates. When a country borrows, it obtains a supply of bills upon the lending country, just as if the borrower had exported goods to the lender. During the life of the loan, only the interest payments affect exchange rates. The lender receives annually a supply of bills on the borrower, which tend to depress the exchange rate of the borrower and to raise the exchange rates of the lender. In the meantime, the principal has no effect on the exchanges. When the loan matures, the payment of the principal has a similar effect as the payment of interest. It may seem strange that borrowing should have the effect of an in- crease of commodity exports. However, this principle is con- tinually applied in normal times. When the exchange rates of a country fall owing to an excess of imports, the central bank raises its interest rate to attract foreign funds. By borrowing, a country may temporarily correct an adverse exchange rate, resulting from an excess of imports. On the other hand, the rise of the exchange rate above the gold parity, as a result of an excess of exports may be corrected by lending money abroad. The central bank attains this end by reducing its interest rate. Finance bills are short-term loans, issued by bankers at a period of the year when there are insufficient export bills available. At a later season of the year, when exports increase, the finance bills are paid off out of the proceeds of commercial bills. The finance bill resembles an accommodation note in its function in that in both cases a person makes a loan without paying cash. Like the short seller who buys later, the issuer of finance bills liquidates by buying. (c) Remittances of Funds — Remittances sent to a country tend to raise its exchange rate. The vast sums sent to Italy by immigrants or taken back with them either seasonally or upon their final return to their native land constituted an important item in the Italian trade balance. Simi- Digitized by Microsoft® 294 INTERNATIONAL FINANCE AND ITS REORGANIZATION larly, the expenditure of tourists, of business men, and of students aided in the maintenance of the exchanges of those European coun- tries which had no large investments abroad or performed none of the international services such as shipping or banking. France, Italy and Switzerland derived considerable funds from these sources. (d) Drafts for Services Performed — Services performed for other nations are equivalent to exports of commodities in their effect on exchange rates. Shipping, jobbing, insurance and banking, carried on by the nationals of Great Britain have made it possible for her to have an excess of imports. Norway derived an income of about 220 million kroner in 1913 from her shipping and her excess of imports amounted to about 160 million kroner. The development of an American merchant marine, or Ameri- can insurance facilities, and the popularization of the dollar draft internationally will furnish the United States with inter- national credits in addition to its commodity exports. In fact, these three services, in addition to the annual interest accruing to the United States, will probably cause ultimately a decline of exports or an increase of imports and a net excess of imports. (e) Summary — A country's demand for exchange is created not only by mer- chandise imports, but also by the invisible debits, loans made or foreign securities purchased, interest payable, expenditure of its nationals abroad or remittances of its residents to other countries, and accounts payable for sundry services. The securities pur- chased abroad may be foreign issues or foreign-held native securi- ties resold or matured. All these factors which create a demand for foreign exchange raise foreign rates on the market of the country or depress its own rate on the foreign markets. A supply of foreign exchange is created not only by exports ofi goods but also by invisible credits, as borrowings by a country, sales of native securities or holdings of foreign issues, interest re- ceivable from abroad, expenditures of foreigners within the country, or remittances to it from abroad, and accounts receivable for sundry services. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR SQS ii. The Trade Balance of the United States Except in time of war, most countries do not keep a record of all the debits and credits which determine the international balance. As a rule, official records only of commodity exports and imports and of gold are available.^ Attempts have been made to obtain the total debits and credits in the trade balance of the United States. For instance, Sir George Paish, attempted to strike such a balance for the year 1908- 1909. He estimated that $6,000 million of United States securities were held abroad, as follows: Million dollars By Great Britain 3500 France 500 Germany 1000 Netherlands 750 Belgium, Switzerland, etc 250 Total 6000 In addition, he estimated that the floating debt, drafts in antici- pation of exports, amounted to $500 million. On this investment of $6,500 million he assumed an annual interest debit of $325 million. Investments by the United States in Cuba and Mexico andt elsewhere, aggregated $1,500 million, interest on which was $75 million. On the net investment of $5,000 million, the net annual interest payable was $250 million. The other debits cal- culated by Paish vi^ere — Million dollars Tourist expenses 175 Remittances to friends through banks, express or postal money order 150 Freights, less coal and supplies bought in United States 25 Total 350 Emigrants and tourists took $60 million out of the country and immigrants brought about the same sum into the country. Debits 'Paish, Sir George, The Trade Balance of the United States. Report of the National Monetary Commission, Doc. 579. Washington: Govern- ment Printing Office, 1910. Digitized by Microsoft® 296 INTERNATIONAL FINANCE AND ITS REORGANIZATION on account of foreign fire and marine insurance were approximately offset by credits arising from life insurance by American companies abroad. The total invisible balance was therefore $600 million approximately.' iii. History of the Trade Balance of the United Statei* (a) Resume — The history of the trade of the United States illustrates the effects of the flow of capital into a country and of the subsequent payments of interest thereon. In the earliest period of American history there was an excess of imports which was offset by the profits of the extensive merchant marine of the United States. In the period from 1821 to 1837 capital was attracted to the United States and as a result the excess of imports increased. In the interval from 1838 to 1849 an excess of exports gradually arose to pay interest on the capital that had previously been in- vested in the United States. In the period from 1850 to 1873 an excess of imports again appeared due to the inflow of foreign capital which developed our railroads and built up the west. In the period from 1874 to 1895 an excess of exports developed due in part to the lessened inflow of capital resulting from the default by many states on their securities. Another factor was the growth of interest charges on the foreign indebtedness and the repayment of maturing loans. In the period from 1896 to 191 4, the excess of exports increased. A large factor was the outflow of funds from the United States in payment of expenditures of Americans travel- ing or living abroad and the increasing volume of remittances of immigrants to their friends and relatives in Europe, as well as the withdrawal of the savings of immigrants who returned to their native lands. The period of the war was characterized by a huge excess of exports due chiefly to the outflow of capital from the United States. 'Paish, George, ibid., pp. 175-195. •Bullock, Chas. J., Williams, John H., and Tucker, Rufus S., "Balance of Trade of the United States," Harvard Review of Economic Statistics, April, 1920. See also Paish, ibid., pages 195 et seg. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR The Statistical resume is given herewith: 297 Average Anntjal Balance of Trade ov the United States By periods from 1821 to 1918 (in million dollars) Fiscal year Exports Imports Excess exports Excess imports 1821-1837 82 93 II 1838-1849 116 113 3 1850-1873 274 338 64 1874-189S 783 670 "3 1896-1914 1691 1204 487 .... 1915-1918 4908 241 1 2497 ;(b) The Pre-War Period— The statistics for the period from 1896 to 19 14 as computed by Bullock and his associates correspond closely to the figures of Sir George Paish in total, but differ slightly in the individual items. Bullock gives the annual net interest payable as $160 million, Paish sets it at $250 million. Both give tourist expenditures as $170 million, and immigrants' remittances as $150 million. Net freight charges according to Bullock were $34 million and to Paish $25 million. Net imports of gold according to Bullock were $9 million; Paish omits this item. Insurance premiums, commis- sions and miscellaneous items according to Bullock were $30 million ; Paish offsets the American payments to foreign companies for fire and marine insurance by foreign payments to American com- panies for life insurance. Finally, Paish includes an item which does not figure in Bullock's calculation, namely the funds taken by emigrants and the funds brought in by immigrants which offset each other and vary from $50 to $60 million per annum. Bullock deducts from these debits net capital borrowings from abroad estimated at $53 million yearly. The net invisible debit balance according to Bullock was about $500 million and according to Paish $600 million, with a fluctuation downward of $100 million in years of depression.^ Digitized by Microsoft® 298 INTERNATIONAL FINANCE AND ITS REORGANIZATION Average Annual Balance of International Accounts or the United States ' in the Period 1896 to 1914 (in million dollars) Items Credits: Excess of exports of merchandise and silver Net borrowings of foreign capital Total Debits: Net interest payable abroad Tourist expenditures Immigrants' remittances Net freight charges Net gold imports Insurance premiums, commissions, etc Total Amounts 487 S3 S40 160 170 ISO 34 9 30 SS3 (c) The War Period— The period of the war, approximately July I, 1914, to De- cember 31, 19 1 8, showed a trade balance which was very different from that of the pre-war period, and in fact represented a stage in the development of the United States which might have taken several decades to attain. The chief factor that characterized the period was an enormous outflow of capital in the form of loans by individuals and by the United States Government. Another factor was the return and repayment of American securities sold to Europe. Finally, imports of gold were in unprecedented volume as compared with former years, though relatively small compared with the two items, loans to Europe and American securities re- turned. These three large credits offset and made possible a volume of exports without parallel in history. Other factors are of interest but of less significance. 'Bullock, ibid., pp. 228-23*. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 299 Net Balance of International Accounts of the United States ' fob THE Period July i, 1914, to December 31, 1918 (in million dollars) Items Credits: Excess of exports of merchandise and silver . Net interest payments receivable Total Debits: Net imports of gold American securities returned Public and private loans to foreign countries Net freight charges Payments for chartering foreign vessels Immigrants' remittances Total Net debit Amounts 11,808 650 I2,4S8 1,029 2,000 8,840 i6S 261 600 12,89s 437 (d) The Outlook— In comparing the pre-war period with the war period the im- portant change in the invisible balance of trade of the United States is that the item, net interest payments, which constituted a debit of $160 million before the war, has become a credit of $525 million after the war, that is assuming that the inter-Allied loans will not be repudiated or canceled. A less significant change is the reduction of our annual debit on account of freight payments from $34 million to a considerably smaller figure or perhaps even to a net credit, depending on the final status of our merchant marine. As the result of these two changes a total net debit of $525 million before the war has been changed to a total net credit of $195 million. Before the war our net invisible debit was liquidated by an excess of exports. On the assumption that our inter-Allied loans will stand, our net invisible credit ought ulti- mately to be balanced by a net excess of imports. However, if the inter-Allied loans are canceled, repudiated, or even suspended, our merchandise balance will probably for a long time to come show a net excess over pre-war figures. •Bullock, ibid. Digitized by Microsoft® 300 INTERNATIONAL FINANCE AND ITS REORGANIZATION iv. Arbitrage'' A brief explanation of arbitrage will enable the reader to follow one of the anomalous and very puzzling financial phenomena of the war — the depreciation of the dollar on the neutral markets of Europe, in spite of a large excess of exports from the United States to these countries. Although most of the world's trade before the war was trans- acted with sterling exchange, the other currencies were quoted in the principal trading centers of the world. Usually, bills on any particular country were quoted at the same percentage of its gold parity on several markets. If, however, a currency was quoted at unequal rates on several markets, foreign exchange dealers would buy the currency in the cheaper market thus raising the rate and sell it in the dearer one, thus depressing the rate until the differ- ences were eliminated. Arbitrage is the process of eliminating the differences in quotations of exchange rates of a country on several markets, or of equalizing the quotations on all markets. As evidence of the equalization of the exchange rates on two or more markets, the following tables are presented. The London rates on Paris and the Paris rates on London are either identical or nearly so : Exchange Rates on United Kingdom, France and Italy ' End of month, 1919 *London on Paris, fr. per £ Paris on London, fr. per £ London on Italy, lire per £ Italy on London, lire per £ January. . February. March . . . April .... May June July August. .. , September October . . . November, December . 25.98 25.98 27.40 28. 22 29.85 29.85 31.02 33-87 35 -45 36. 22 39-35 40.05 25.98 25,98 27.62 28.37 29.40 29.71 31-42 33-97 34-70 36-05 39-26 40,02 ,•50-31 30-31 37.00 34-75 39 SO 36.87 37-65 40-85 41. 10 43-37 49.00 49.12 30 30 33 35 37 36 37 40 41 43 49 49 -31 31 -5° .20 ■9S .87 .69 -7S .20 .07 .00 •37 *London quotations are cable averages from Thursday of the last week of the month as quoted by the London Economist. Foreign quota- tions on London are averages for the particular date quoted by the Economist for the last week of the month. ' Schmidt, F., Arbitrage und Wechselkurse, Schmollers Jahrbueh, 1919, xliii, pp. 203-262. 'Federal Reserve Bulletin, March, 1920, Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 301 During most of the year the quotations correspond closely. The unusually wide variations are due to the violent fluctuations of the exchange rates, resulting from the abandonment of their stabilization, and the fact that quotations do not cover identical days. Perhaps a clearer evidence of the effects of arbitrage in equaliz- ing exchange rates throughout the world may be had from a com- parison of sterling rates in Newr York with the relative rates of both sterling and dollars on a third market, Copenhagen. The rates are the high quotations for the months and show a fair cor- respondence from 1 91 5 onwards. The 191 4 quotations show dis- crepancies due to the erratic fluctuations in the early months of the war. The Effect of Arbitrage on Sterling and Dollars Based on gold parity as 100 Montli High Rates in Copenhagen * High rates in On London On New York Ratio New York t on London 1914 July {a) 100.93 los . 72 100.00 98-56 94.16 97.08 90.91 84.80 84-58 98-34 108.97 109.69 (6) 100.67 107.77 103.22 101.61 95-98 100.00 93-57 87-94 87-13 100-80 114.48 132-44 (a) : (i) 100.3 97-1 96.8 97.0 98.1 97-1 97-1 96-5 97-1 97-4 95-2 82.9 I 13 -02 December 191S 100.53 98-34 December 1916 June 97-43 97-79 December 1917 97-75 97-72 December 1918 Tune 97.66 97.71 December 1919 97-78 95-24 November 85-53 "Federal Reserve Bulletin, January, 1920, p. 44. tFederal Reserve Bulletin, September, 1918, p. 837, and January, 1920, p. 42. Digitized^ by Microsoft® 302 INTERNATIONAL TINANCE AND ITS REORGANIZATION As final evidence of the effects of arbitrage in equalizing ex- change rates we give herewith the rates for Swedish kroner on Basle and then for comparison the rates on both the Basle and Stockholm markets of sterling, franc, dollar, and mark bills. The ratio of the rates on the Swiss market to rates on the Swedish market of bills in the four currencies corresponds very closely to the Swiss quotations for Swedish kroners. The Effect of Arbitrage on Swiss Francs and Swedish Kroners' Based on a gold parity as loo Currency and Market July, 1914 Jan., 191S July, 191S Jan 1916 July, 1916 Jan., 1917 July. 1917 Dec., 1917 Swedish kroner on Basle. . . Sterling on Basle Sterling on Stockholm Francs on Basle 99.37 99.80 100.50 100.03 100.74 99.18 100, So 99.36 100.13 95-22 loi . 70 106.17 102.15 107.62 102.07 107.23 93.33 98.32 100.08 101.62 100.99 95.00 95.78 103 , 62 103.22 88.29 88. 38 102.60 98.33 95. 10 88.8s 86.17 100,34 97.32 77.25 76.17 109.08 100.07 92.13 89.7s 82.75 102.27 94.93 75.60 71.49 106.60 94.88 88.89 86.10 80.94 97.06 91.53 68.53 64.14 108.04 85.84 83.70 79.00 77.3s 88.37 86.03 SI. 43 51.25 106.92 82.7s 76.93 76.70 Francs on Stockholm 71.76 Dollars on Stockholm 79.60 Marks on Stockholm ^'.ts It is remarkable that with the varying rates of decline of mark, franc, sterling and dollar exchange the relative position of the Swiss francs and Swedish kroner should have been maintained alike on all markets.'^" Before the war the differences between the relative levels of any currency on two foreign markets was very slight. During the war the "pegging" of the Allied exchanges resulted in the establish- ment of different levels for the same currency in the "pegged" New York market and in the free neutral markets. As a result of arbitrage transactions the "pegged" currency, sterling, franc or lira, was bought in the free neutral markets where it fell to its natural level and sold in the "pegged" New York market where it was maintained at an artificially high level. As a result of this selling ° Swedish rates compiled from Kommersiella Middelanden, January 15, 1918, in Federal Reserve Bulletin, May, 1918, p. 380. Swiss rates compiled from the Swiss Bankvereins' Revue Economique et Financiire, 1914-1917, in Federal Reserve Bulletin, May, 1918, p. 391. '"The British Board of Trade Journal of January 8, 1920, and sub- sequent dates gave the foreign exchange rates of several of the leading countries on London, Paris and New York. These were calculated in percentage of gold parity and indicate the close correspondence in tH« relative rates as the result of arbitrage transactions. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 303 pressure on New York, dollar exchange declined on the neutral markets in sympathy with the Allied exchanges which it supported. To correct this condition several merchants and one member of the Senate urged the prohibition of arbitrage. However, the effect would have been detrimental to Allied military success and the proposal was not adopted. As the result of the release of the "peg," or the abandonment of the stabilization of the Allied exchanges, the differences in the exchange rates of sterling, for instance, on the Zurich and New York markets were eliminated. Arbitrage again operated to equalize the relative levels of the currencies on all markets. British, French and Belgian exchange declined in New York to the levels they maintained in the neutral markets. The dollar, on the other hand, rose on all markets. V. Correctives^'^ — The consideration of the correctives of the foreign exchanges may be reduced to two cases (a) if gold flows freely and (b) if gold does not flow. The first case may be sub- divided further into two cases, (i) where the countries involved are on a gold basis, and (2) where the countries involved are on a paper basis. (a) Between Countries on a Gold Basis — Between countries on a gold basis, with gold flowing freely exchange rates can fluctuate only between narrow limits, namely, the upper and lower gold points. A country with an excess of exports may have more bills for sale than it needs for the settle- ments of all its debits. This surplus will depress the exchange rates of foreign countries in its market. On the other hand foreign countries will have insufficient bills on this exporting country and the rates for its bills will therefore rise. When the rise above gold parity exceeds the cost of packing, insuring and shipping gold, mer- chants will prefer to ship gold, and thus limit the rise in exchange. How does the gold shipment correct the appreciated exchange ? I. Changes in the gold supply — When in payment for an excess of exports a country receives gold, prices tend to rise because of the increased quantity of gold. Foreign purchases in this country "Further discussion may be found in Goschen, Theory of the Foreign Exchanges, pp. 60, 63, 70, 71, 74, 78. Also Brown, H. G., Principles of Commerce, pp. 142-151. Digitized by Microsoft® 304 INTERNATIONAL FINANCE AND ITS REORGANIZATION then tend to cease and thus its exports decline. Simultaneously and as a result of high prices imports increase. When in settlement of an excess of imports a country must ship gold, prices tend to fall as a result of the diminished supply of gold. Imports by this country then tend to decline, and exports tend to increase, thus eliminating its excess of imports. A flow of gold between the two countries changes their relative price levels and tends to correct the condition that caused the flow. 2. Changes in rates — Fluctuations of exchange rates In gold countries are self -correctives. If sterling sells for $4.91 in New York owing to a scarcity of bills on London, the increased pur- chasing power of sterling induces British merchants to buy in New York and thus create a supply of the needed sterling ex- change. Simultaneously American merchants reduce purchases in Great Britain and thus decrease the demand for sterling. Similarly, if sterling sells for $4.81 in New York, owing to an excess of bills on London, the lower cost of sterling induces Americans to buy goods in England and thus create a demand for sterling bills. Simultaneously British merchants reduce purchases in the United States and thus decrease the supply of sterling bills. Therefore an excess of exports, raising exchange rates, raises prices to the foreigner, and thus tends to check exports. An excess of imports, lowering exchange rates, raises the price of foreign goods, and thus tends to check imports. 3. Changes in the volume of goods — ^A growing excess of exports tends to create a shortage of goods in the exporting country and thus tends to check exports. A growing excess of imports tends to create a surplus of goods and thus tends to check imports. Therefore a flow of trade in one direction tends to correct itself through a change in the price level which is brought about by a change either in the volume of gold. In the exchange rates, or in the volume of goods. (b) Between Countries on a Non-Gold Basis, If Gold Flows^' — If gold is free to move, a country on a paper basis or on s " For further discussion see papers, "International Trade Under De- preciated Paper," by F. W. Taussig and Jacob H. Hollander, May, 1917, and August, 1918, Quarterly Journal of Economics. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WOEID WAR 305 silver basis reacts in a way similar to countries on a gold basis. The rate of exchange in the paper or silver country on gold coun- tries depends on the cost of gold in terms of paper or silver. Its exchange rates rise as its paper or its silver depreciates in relation to gold. Its exchange rates fall as its paper or its silver appreciates in relation to gold. On the other hand, the rate of exchange in the gold countries on the paper or silver country depends on the cost in gold of the paper or silver money. As the paper or silver de- preciates, exchange' on the paper or silver country falls. As paper or silver appreciates, exchange on the paper or silver country rises. In the paper or silver country fhe upper limit of exchange on the gold country cannot exceed the paper or silver cost of gold plus the cost of shipping it, provided the premium is regularly established and is not artificially restricted. In a country with inconvertible paper currency gold tends to lose its character as a circulating medium, and to become merchan- dise and to react like other commodities. Therefore when there is an excessive issue of paper all prices rise, including the price of gold. But gold is purchasable and exportable like any other commodity. How do the correctives of exchange operate? 1. Changes in gold supply — ^The outflow of gold from a paper country tends to make gold dear in relation to other goods. Paper prices rise because of the decreasing likelihood of redemption. But gold prices fall, just as in a country on a gold basis. There- fore exports increase, imports decrease and as a result gold flows back to the paper-standard country. Thus, although the fluctua- tions are wider under a regime of inconvertible paper, a gold flow operates to correct the exchanges in a paper-standard country, in the same way as in a gold-standard country. 2. Changes in rates — In a country on a paper basis the extremes of fluctuation are determined by the cost of shipping gold, which in turn depends upon the depreciation of the paper. The fluctuations in exchange rates of a non-gold standard country make more or less profitable the purchase of goods within it, and these fluctuations tend to act as correctives of the trade conditions which caused them. The limits of fluctuation in foreign exchange rates of the paper country will be the cost of shipping gold plus the extent of Digitized by Microsoft® 306 INTERNATIONAL FINANCE AND ITS REORGANIZATION the premium on gold, provided the premium is regularly estab- lished and provided gold flows freely. 3. Changes in the volume of goods — ^The surplus or scarcity of goods tends to correct itself. If a paper-standard country imports heavily, the larger supply of goods in relation to paper and to gold tends to make prices lower in either paper or gold. In the exporting country on a paper basis the relative scarcity of goods tends to make prices higher, measured either in paper or gold. For this reason more goods will be bought with gold in the country having an excess of imports and goods therefore tend to flow out of the country. Excess buying by a paper country in another would be cor- rected by the flow of goods, by the effect of that flow on prices in the two countries, and by the relation of goods to gold, as indicated in the case of two countries on a gold basis. (c) Between Countries on a Non-Gold Basis If Gold Does Not Flow — If a country has little or no gold or if the exportation of gold is prohibited, the fluctuations in exchange rates are much wider than in the case noted above, for the limits set by the gold points are removed. This is the condition in most of the countries of Europe to-day. Since gold cannot be had for paper, since it is illegal to pay a premium, and since the gold bullion is in the control of the central banks, gold does not flow and exchange rates fluctuate violently. When gold does not flow and when there is no recognized premium on paper the relative value of paper to gold has no significance in determining exchange rates. The sole deter- minants of the rates of exchange then are the supply of and demand for bills. If the demand for bills exceeds the supply, the country cannot effect a settlement except by reducing its imports or in- creasing its exports. Countries with inconvertible paper standards usually have an excess of imports. A paper regime usually follows a period of heavy foreign borrowing and of an excess of imports such as pre- vailed in the belligerent countries of Europe during the World War. During a further period of an excess of imports, the ex- portation of gold must be prohibited, otherwise the supply would be drained. When conditions improve so that credits exceed debits Digitized by Microsoft® PEmCIPLES AND PRACTICE IN THE WORLD WAR 307 and gold flows into the country, the prohibition on the exporta- tion of gold may be removed. Is it to be assumed then that there are no limits to the fluctua- tions in exchange rates of a country on an inconvertible paper basis? In the absence of a flow of gold the two other correctives mentioned above still apply. However they are not so sensitive. Under conditions of the free flow of gold, fluctuations must be narrow because gold is universally current; because it is compact and because the cost of shipping it is low, in normal times perhaps I per cent of its value. 1. Changes in volume of goods — ^A tendency to a surplus of goods in the importing country and a scarcity of goods in the exporting country tends to correct a flow of commodities in one direction. Therefore the fluctuations of exchange rates are not utterly without limit. However, these limits are very wide, for several reasons. Commodities are not so universally current as gold. Only such commodities are imported as are wanted, only such are exported as are available. Again the cost of shipping commodities is greater, relative to price than of shipping gold, and depends on the character and the bulk. The period following the World War will therefore be characterized by very wide fluctuations of the exchanges of countries with an inconvertible paper standard, but these fluctuations will not be unlimited. The shortage and glut of goods will affect the relative price levels or barter levels between importing and exporting countries, so that a strong flow of trade in one direction will tend to correct itself. I 2. Changes in rates — ^The relative price levels will also be affected more directly by variations in exchange rates, as in the case of gold standard countries explained above. (d) Summary — Exchange rates between countries on a gold basis are corrected by a flow of gold. The exchange rates respond immediately and fluctuations are kept within narrow limits. Less immediate cor- rectives are changes in the rates themselves or in the relative price levels and changes in the relative abundance or scarcity of goods. Between countries on a paper basis which do not restrict the free flow of gold the same principles apply, except that the gold points which restrict the fluctuations of the paper exchanges depend Digitized by Microsoft® 30B INTERNATIONAL FINANCE AND ITS REORGANIZATION upon the paper premium. That is, the extreme fluctuation of the paper exchanges equals the cost of gold in terms of paper plus the cost of shipping gold. The same reasoning applies to a country with a silver standard. If the movement of specie is prohibited, the gold points are re- moved, and fluctuations are more violent. The sole control is the tendency of a flow of trade in one direction to check itself and to induce a reverse flow, either as a result of the relative scarcity or abundance of goods or more directly as the result of the changes in price levels which follow variations in exchange rates. B. Quotations The course of the several exchange rates before the war may best be studied on the London market, because all the important currencies were quoted there and 'London was a free gold market A study of exchange rates during and after the World War must be based on New York quotations, because, except during the period from October, 1917, to June, 1919, New York constituted a free gold market. Therefore depreciation of exchange rates in New York measured the discount on paper money. The highest records for the exchange rates of the belligerents since the beginning of the war were reached in August, 1914, when Europe recalled its funds from foreign countries. The highest records for the neutrals were attained during the period when sterling was pegged in New York, and before measures to reduce the premium were effected. The lowest figures since August, 19 1 4, alike for both belligerents and neutrals were quoted during and after 1920. High and Low Exchange Rate in New York from August i, 1914, to December 31, 1920 Currency Sterling Francs Lire Marks Kronen (Austrian) Guilders Francs (Swiss) . . . Pesetas Kroner fSwedish). Kroner (Danish).. Parity High Low $4.8665 $7.0000 $3.1800 .1930 •3312 .0570 .1930 • 2500 .0330 .2382 .2730 .0101 .2026 .2300 .0020 .4020 .S237 .2900 .1930 ■ 2S97 •1505 .1930 .3000 .1183 .2680 .4700 • 1630 .2680 .3900 •130S Date of high Date of low Aug. 4, 1914 Aug. 4, 1914 Aug. 4, 1914 Aug. Aug. 4. 1914 4, 1914 Feb. 4, 1920 Nov. II, 1920 Nov. 8, 1920 Tan. 28, 1920 Dec. 17, 1920 Aug. 9. 1918 May 20, 1918 Apnl 17, 1918 Nov. 2, 191 7 Oct. 27, 1917 Nov, Nov. 6, 1920 8, 1920 Nov. 13, 1920 Feb. 4, 1920 Nov. 8, 1920 Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 309 Qjrresponding to the lowest quotation for sterling exchange in New York, the price for gold bullion in London rose to the highest record on February 5, 1920, and was quoted at 127s. 4d, compared to parity of 85s. per ounce. The quotations following are expressed not absolutely in terms of currency but relatively in terms of gold parity, which will be taken as 100 throughout. This method of quotation is not new in the countries of the Latin Monetary Union, where depreciated exchanges are always under icxj and appreciated rates always over 100. Should a world monetary unit eventually be established all quotations being based on 100 as gold parity would read as the relative quotations in the tables given below. 1. New York Rates on Allied Powers in the World War (a) From August, 1914, to April, 1917 — At the outbreak of the war exchange rates fluctuated violently. Sterling reached $7.00 in August, declined to about $5.00 in Oc- tober, touched parity in December, and by September, 191 5, had gone down to $4.50. Europe recalled the short-term funds which had been loaned in the New York market. This caused a demand in New York for exchange on London, Paris and Milan and as a result for some months after the outbreak of the war these ex- changes ruled above par. However, with the increase of exports from the United States to Europe these three exchanges began to decline on the New York market, but were stabilized by Great Britain through the resale of American securities distributed in Europe, the floating of loans, both secured and unsecured, in New York, and the sale of British treasury bills. New York rates for sterling fluctuated relatively little during this period although the difficulty of financing became increasingly severe during the winter of 1916-1917. The rate was maintained at about $4.76, or at 97.9 per cent of parity. French francs declined far more than did sterling. The decline was very gradual, from 19.3 cents, or parity, maintained in January and February, 1915, down to 17. i cents, or 88.7 per cent of parity, in the winter of 1916-1917. Lira rates declined more than either of the others. They can hardly be said to have been stabilized, rather there was a continuous decline from 19.3 cents, or parity, in October, 1914, down to 13.I cents, or 67.9 per cent of parity^ in March, 19 17. Digitized by Microsoft® 310 INTERNATIONAL FINANCE AND ITS REORGANIZATION il 1 1' i \ \ 1 8 ^' ^||§S?S!'§%S 4e R! S S 8 ^ t>i . - [ ^j^ tr\ ir: \ E'"- JOO V, J: "t ' ' "5 : isr ."J ± "1 : iWK 0= 's -i^ k.™. • f- — ^^ xuir% r s ^' * "*■---. ■• afi^^ "^ i ►- j^w s s i. / 2i&K O J '- -f^' J(C%/ 1 -S it V- '£SE/ (> " \ t r 'i/*f* : \ . : y" : K - - \ - 1 <■ /^ M ^ V ^; j^ " 4A ^ IV \ J. - ^ - ^ ^ lij 7 ~r --' -H 4 ■^ 2. /^^ . l^ 1 - 1 - - - 7- t- S* i JL IC- >j t ^^-., 7 '*"' ^J ^S -1^.- * sC; -^. "^ ^ ' : :: J *\,^>- ~- 7^ KV •Q J- 1 21 ^ : " "t* >; 4 ^ ^ / ^""f^f O I -,^ "T i {_ -JJQ y IJ . -J ^"^ ibHr k i ^ ^ . X -t /- k 7 y I S^K .nrto T V'' k- ^ /J - _L - t -. - lij -^'^ ^S . V S2 2CV^ >= z ^ ^''$ S2/ L^ 7 Sv ~ -- -- "^ s >■ t ^ i ^ L ~? ^'^ *~l^' <: 5 \ i^^ -I " I--" ^'' ' (0 4 W ^ - .if f'" - III ^ X a r 1 I £ kJ t ^ \\ ; i\% : ^ L / J^- 4<^ ir 7 / J - 33 ;3u»/*^ / "f -'' lU l_ V L ,^ ( K^ ^>1 ^ ^/ ,.=:"^''Z^--". 'T X z -< -N •^ ^ <' -«^x - (S 3^ t--^"^- y ^5^ ilS — ??? ^ ■^^ «. -^ y -i«SP§ S SIISSJS}^^^, !^ t« § !S 8 ^ ^ c n a. o V a s ^-° (14 IS Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 3" I 8 I i I VJI/ ■Wr II ^ ^ * s S 1 5 ^! si ^r rl 5| ^1 li ^t a a Digitized by Microsoft® 312 INTEENATIONAL FINANCE AND ITS REORGANIZATION (b) From April, igiy, to March, IQ19 — During this period of about twQ years the exchange rates ol the Allied powers on New York were stabilized. The method and effects will be discussed later. At present we are primarily inter- ested in the quotations. During this period the sterling rates on New York remained practically stationary at $4.76, or at 97.9 per cent of parity. Franc rates in New York rose upon the entry of the United States into the war from 17.1 cents to about 17.5 cents, or about 90.8 per cent of parity, which rate was maintained through July, 1918. From July, 1918, through March, 1919, when the "peg" was released, francs ruled at 18.3 cents, or at about 95.0 per cent or parity. French exchange was stabilized by means of United States government advances as well as by loans by Great Britain. The lira rates were stabilized least successfully. From about 13.1 cents, or about 67.9 per cent of parity, the lira rose slightly upon the entry of the United States into the war, but declined down to 11. i cents, or 57.8 per cent of parity in May, 1 9 18, when as the result of aid by the United States Treasury they were stabilized at 15.7 cents, or 81.4 per cent of parity. This rate was maintained from August, 1918, through March, 1919. 1(c) After March, iQig — In March, 1919, the Allied exchanges were "unpegged" on the New York market and dropped precipitately thereafter. Of the three Allied exchanges, sterling dropped least and lire declined most, with francs following closely. Before the "peg" was released sterling was quoted at about $4.76. Month by month the rates fell and in December, 1919, the high rate for sight drafts during the month was $3.98. During the early part of 1920 there was a slight recovery followed by a subsequent relapse, and a further de- cline. Toward the end of the year the rates were maintained around $3.50. The high and low demand quotations for 1920 were $4.06 and $3.19 as compared with $4.76 and $3.66 for the year 1919.^^ The Paris rates declined to a far greater extent. Before the "peg" was released francs were quoted around 18.33 cents per franc. Thereafter, the decline in the rate was continuous prac- tically. In December, 1919, the high rate during the month was 10.08 cents per franc. In 1920 the decline continued through "New York Times, Annalist, January 3, ijai. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 313 April, during which month the high rate was 6.93 cents. There was a recovery during May and June and a subsequent decline. In October the high rate for the month was 6.75 cents and the end of the year was characterized by further declines. The high and low rate for francs in 1920 was 9.38 cents and 5.70 cents,, as compared with 18.35 cents and 8.50 cents for the year 1919. Monthly High Demand Rates m New York of Chrbency op Alued Powers in the World War '* Based on gold parity as 100 Parities London. Paris, Milan, $4.8665 I619.3 ?I9.3 Percent Percent Percent 100 . so 100.62 100.36 113.02 ri2.64 105.75 114.25 101.61 105.75 104.03 102. S9 98.70 102.33 102.59 100.21 100.87 101.71 97.41 100. S3 101.40 99.07 99.74 100.26 97-31 99 bs 100,00 95-96 98 89 98.50 91-71 98 63 97.46 89.79 98 63 97.46 90.0s 98 34 9S.34 87.72 98 04 93.63 85.49 97 Sb 91.76 83.16 97 20 89.9° 83.83 97 09 89.90 83.32 96 8b 89.92 80.57 97-43 89.17 79.53 98.22 88.86 79.12 97 94 88.50 77.46 97 91 88.19 79.69 97 91 87.36 82.12 97 86 87.56 83-58 97 79 87.82 81-61 97 79 87.72 81-24 97 79 87.98 80.16 97 97 88.76 80.62 97 7S 88.76 80.16 96 94 88.70 77.93 97 7S 88.81 77-82 9t.78 88.70 75.23 97 77 88.65 73-16 97 72 88.70 67.93 97 78 91.24 75-13 97 72 90.78 73.99 97 72 9°.S2 73.63 97 74 90.41 72.18 97 72 89.90 71.61 Parities London, $4-8665 Paris, ^19-3 Milan, pig.s 1914 June July August September. . October. . . . November. . December - - 191S January. . - . February. . . March April May June July August September. . October . . . - November. . December. - 1916 Januaiy February- - . March April May June July August September. . October. . . - November. . December. . 1917 January February. . . March April May June July August 1917 Percent September 97-72 October 97.67 November 97-65 December 97.66 1918 January February. . March April May June July August September. October November. . December. . 1919 January. . . . February. . . March April May. . . June. July August September. , October . . . . November. . December. . 1920 January. . . February. . March .... April May June Jvay August. - - - September. October 97.68 97.68 97-68 97-71 97-71 97-71 97-68 97-98 97-71 97-71 97-76 97-78 97-78 97-78 97-77 96.01 96.42 95.24 93-91 89.49 87.59 86.97 85.53 81.94 77. S3 70.94 81.22 82.55 80.4s 81.94 81.19 76.18 73.20 72.07 Percent 89.79 90.73 90.36 90.41 90.83 90.73 90.52 90.62 90.83 90.67 90.67 94.61 94-72 94-77 96.11 95. 02 94-97 94.96 94 .81 88.11 85.36 82.63 79.77 70.97 66.25 61.83 58.58 52.23 48.08 38.76 39 17 35.91 41.19 43.47 44.2s 39.43 36.32 34.97 Percent 68.86 67.10 65.23 64.87 62.33 60.93 62.07 58-96 S7-77 58-50 64.66 81.40 81.3s 81.61 81.61 81.60 81.40 81.44 81.44 73.81 69.08 66.00 65.83 60.10 54.71 53.14 SI. 50 41.98 39-12 32-12 29.74 25.44 31.30 32.18 31.87 27.41 24.30 21.66 "Federal Reserve Bulletin, September, 1918, pp. 837, et seq.; January, 1920, pp. 49-50; November, igzo, pp. 1159-60. Digitized by Microsoft® 314 INTERNATIONAL FINANCE AND ITS REORGANIZATION Lire, which were stabilized at about 15.72 cents before the "peg" was released, declined continuously to 8. 10 cents, the high rate during the month of December, 1919. During 1920 the fall continued almost without interruption and in December, 1920, the rate fluctuated around 3.40 cents. The high and low quotations for 1920 were 7.57 cents and 3.34 cents as compared with 15.72 cents and 7.35 cents for 1919. Toward the end of 1920 British exchange was at about 72 per cent of parity, French exchange at about 30 per cent, and Italian exchange at about 17 per cent of parity, in New York. ii. New York Rates on Neutral Powers (a) From August, igi4 to April, 1917— Dutch guilders and Swiss francs rose in the New York market shortly after the outbreak of the war, probably because of the sharp decline in American exports to Europe and as a result of the increase of exports of Holland and Switzerland to the warring countries. Most of the neutral exchanges declined during 191 5 as a result of the enormous increase of exports from the United States. Guilders and Swedish kroner rose in the New York market, possibly owing to the liquidation of securities on German account. Spanish pesetas, Swiss francs, and Argentine pesos were at a discount through 191 5 and in the early part of 1 91 6. How- ever, as the efforts to "peg" sterling in the New York market increased all the currencies of neutral Europe tended to rise in New York. Before the United States entered the war the pre- miums on the neutral currencies had been considerable. Dutch 'guilders had risen to a premium of 14 per cent, Swedish kroner to 16 per cent, Swiss francs to 5 per cent, Spanish pesetas to 10 per cent and Argentine pesos to 5 per cent. In spite of the large excess of exports of the United States the neutral currencies were at a premium in New York because of the large loans by American investors to the Allied powers. At the time it is contracted a loan, like imports, tends to depress exchange rates. Therefore, our loans tended to neutralize the effect of our large excess of exports in creating favorable exchange rates on the dollar. The table for the Allied currencies from 191 4 through 1020 is given herewith : Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 315 (b) From April, igiy to March, igig — During this period the neutral exchanges without exception were at a premium which reached levels that broke all records since the Civil War. The highest premium attained by Dutch guilders was 31 per cent, by Swedish kroner 70 per cent, by Swiss francs 35 per cent, by Spanish pesetas 54 per cent and by Argentine pesos 8 per cent. The details of these fluctuations and the reasons therefor will be discussed more fully later. (c) After March, JQig " — After March, 1919, when the "peg" on the Allied exchanges was released in the New^ York market, the free play of economic forces again took effect. In view of the large excess of exports of the United States dollar exchange rose on all markets and con- versely all currencies declined on the New York market with a fevir exceptions, notably Argentina and Chile, in the trade with which countries the United States had temporarily an excess of imports. The premium of 9 per cent on Spanish pesetas in Febru- ary and March, 1919, declined and by September was wiped out) During 1920 Spanish exchange declined continuously and by the end of 1920 was quoted at about 12.90 cents, at a discount of about 33 per cent. The high and low demand rates for igig were 20.90 cents and 18.70 cents and for 1920 about ig.30 cents and 11.75 cents. Swiss francs were at a premium of about 7 per cent during March, 1919. The rate declined subsequently and went to a dis- count of about 8 per cent in August, 1919. At the end of Decem- ber, 1920, the Swiss franc was at a discount of about 22 per cent, declining fairly continuously throughout the year. The high and low rates for demand exchange for the year 1920 were 18.37 cents and 15.05 cents, as compared with 20.62 cents and 17.42 cents for the year 1919. Swedish kroner were at a premium of about 5 per cent during February and March, 1919, but after the "peg" was released the rate dropped fairly continuously to about 83 per cent of parity. During 1920 the rate declined to about 71.5 per cent of parity in February, rose intermittenly during the next five months and from "The percentages of parity are taken from Federal Reserve Bulletin, November, 1920, and the New York Times high and low quotations are used. Digitized by Microsoft® 3i6 INTERNATIONAL FINANCE AND ITS REORGANIZATION ll 1 1 1 1 II 1 ^^«§^6i$$?§^§SS ^^S$§^^^$«ieft; § ::^:::_:':_: :^:-t:: itT'S^" """"""--" ^ S --_,...s = = =!:-:" -__± _ ifcs^f - - - -S ^.r::: t.^ 5s ^^^'Ti ^ S - ,,,;#! TCa^X X ^ ^ ■ .'I'^jt \ it - -S-5 1 :^='"":"a:iL " jjr-tr""^. ""::::::::: ^55 § __: A <'?it-- 5 J) Sw R==,.,-.S',, — --:tt6i. X U r-r---*^ y--=-=5=i:;f==-'rt"^ |>U 4- '^^ 3 * t-^ "** --hi- i^ S ^ '■ Mr c5 ..*----■"" t ■■ ,.- ■"' ^s. Jkr "•» ""' — ■- I :^ L---^ ^ J20 S ?*■-■*-■--.., ~ "y^- M -■' ■•■-*=.;; -'■"^^-•, 1 :::__:. : s: ■>+ (^ - - - - -^"i^- •.,< fc ' 1^ "^ > Is ^ Ja j^ ^ u ^ ■*■• ^ jf ' n u g tL ' B "^ Q ± ^ u ^ W ^ ::::_::::::: :::3:.52 i::: ::::-:"--^ fe __ __ ^5-5 ^ ^ : _„._z/E ^0 .^ /tJ^^ --^^ ^ ^i^ ijE-^. ^-^ ^ ::i!i::^$5±:::]:::::::::::^ ^ - --- - --- - " ^ ., \ "Nil "^ i j,C^y ^ :::::: :::::: - _ i; ^ '■ JL _|_ ^ _ _ _ «z/ ^ ._. .. . § ^ T fe ^ £ r^ flf ^ 7>nA s; ^ """ I' : : :: :: :: ::: : a ^ ^ J t^,,^ , ^ \Q ::: rj: i±"S fc 11 ^ — *" - 5 ___ _- '" ? - >•" jw t j, .^ .a^_>f___^ GJ 5r, :::::::";! — ftt ^ ,'^? ^_. — ^,55. 5 S s "■JS -Bnr Q .: I-.;:::::: ** tSl^^tlliS^^SS ^^§§§!8S!§%«>?R! a Q. B o > u u •5 s a "2 ai C O « g Digitized by Microsoft® PEINCrPLES AND PRACTICE IN THE WORLD WAR 317 1 1 1 1 1 i 1 1 1 ^509^^%5§ klU30y3J 1 0) mn ■ffiy ■A*'/' ■AW no ■M3S vnv xinr lUflP AM ■Hdi' vm ■S3J ■hivr ■psa ■/VU 'CO ^ i 1 ^ f- t ^ (1 / * i 'f '^'/ fil \ \ \ \ u 1 '--:% V u 3 ' ? ■V /^ ■■■■ f \ * */' ' / g. i \ 'V / •d a. A 1 * \ s'tJ ■M3^ xinr ■HJV nm ■fr^-1 % V 'm S. •^ fV 7^ ft 'li 2 u .y ? 1 I ■ ■uvr ^s"a5SR?5S kJ.uspy3J iiill ltlil J ill Digitized by Microsoft® 3l8 INTERNATIONAL FINANCE AND ITS REORGANIZATION August to the end of the year declined fairly continuously to a low level of 71.5 per cent of parity in December. The high and Monthly High Demand Rates in New York of CuRMNaES or Countries Neutral in the World War " Based on gold parity as 100 Amster- Stock- Zurich, Madrid, Buen OS Amster- Stock- 1 Zurich,!Madrid, Buenos Mos., dam, holm, Aires Mos., dam, holm, ^^A Parity 40.2 26.8 19.3 19-3 96-4 5 Parity 40.2 26.8 19.3 19.3 96.48 cents cents cents cents cent. cents cents cents cents cents 1914 , une 100.27 100,62 1917 Aug. 105.42 126.31 116.29 118.39 101.88 . uly 102.61 111.4s Sept. 104.80 128.36 115.13 124.87 101.84 Aug. 104. 48 Oct. 113.80 156.72:117.77 122.54 104. IS Sept. 103.86 103 . 63 Nov. 112.56 169.781119.38 122.80 no. 75 Oct. 105.72 103.01 Dec. 110.70 138.99 121.35 126.42 112.24 Nov. 101.67 100.62 Dec. 101.04 99-95 1918 Jan. 110.07 127.80 119.12 126.42 108.32 Feb. 113.43 125.00,116.17 130.83 103.7s 1915 Mar. 116.29 126.87 120.05 132.80 104.69 Tan. Feb. 100. 75 93.84 99.17 99-69 April May 120.02 128.73 121.92 154.15 103.30 roo.27 93.10 97.88 100.98 12s. 62 129.66 135.28 147.15 103.44 Mar. 99.50 95. 7> 96.84 ioa.49 June 126.87 132.84 131.50 147-93 102.19 April May 98.26 96.27 97.36 103.89 July 129.35 133.58 131.50 142.7s 105.61 98.41 97.01 97.88 102 . 59 Aug. 131.22 135-26 132.33 137.31 104.97 June 99.35 98.77 98.50 98.86 Sept. 123.13 125.93 119.38 121.09 106.01 July 99.6s 98.51 96.84 99.64 Oct. 116.29 118.66 112.18 117.36 106.83 Aug. TOO. 27 98.63 97,56 100.31 Nov. los . 10 108.21 105 . 28 i'J7.2S 107.18 Sept. ZOO. 42 97.01 98.70 98.45 97 :« ! Dec. 106.34 109.88 108.39 104.66 106 . 83 Oct. 103 . 23 97.95 98.50 98.70 98.94 Nov. t04.4B 104.85 97., ?6 98.60 98.3. 1919 Dec. 108. 21 104.66 98.86 97.93 98.91 fr?- 106.34 10S.58 107.49 104.3s 106.36 Feb. 102.61 105.04 106.72 109.33 105.89 1916 Mar. 102.30 105.04 107.25 109.33 106.01 Jan. 114. 10 106.02 104.96 100.98 99.07 99.2a ^?'^ 102.61 101.21 105.31 105.57 104.53 Feb. 107 . 28 100,05 99-74 104.71 May 100. 12 99.63 105.21 104.92 105.71 Mar. 106.34 108.21 99-43 100.36 100.4c > June 97.64 97.95 100.03 103.94 103 . 82 April May 107.59 113.81 100.21 101.81 100.4c > July 96.39 95.15 98.86 102 . 18 101.88 104. IS 116.60 100.05 103.36 99.6c Aug. 93.44 92.91 92.85 102.33 99.82 June July 103.86 113.43 99.07 107,25 99-53 Sept. 94.84 91.79 94.72 99-74 101.88 103.08 108.77 105,18 99-53 Oct 94.68 91.79 93.19 99-90 99.76 Aug. 103.08 107.46 97 '88 104.66 98.21 Nov. 94.53 88.99 94- 20 104.14 102.18 Sept. 102.29 107.09 97.88 104.46 99. 8e Dec. 95. is 83.21 104.04 103. II 101.88 Oct. 102.46 106.34 98.55 10s . 18 101.65 Nov. IOI.99 106,16 100.21 106.48 X02 . 2, 1920 Dec. 101.67 109.89 105.08 no. 10 105.75 Jan. 97-33 80.41 94-72 99-48 101.88 Feb. 94-22 Kisi 89.79 93.26 102.77 1917 Mar. 92-35 89.02 92.7s \IIM Jan. Feb. 101.52 110.63 103.63 110.10 104.4s April May 93.28 82.84 93.89 92.7s 87.93 101.37 110.45 103.63 110.62 104.73 91.29 80. »8 92.7s 100.70 Mar. 100, 75 III. 94 103.32 112.69 103.7s Tune 91.23 82.00 82.46 94 56 86.53 103.77 98.3s April 103 . 86 113.06 102. 80 "3-47 101.0, July 90.30 93.99 8s.fo May 102.61 III. 94 102,69 117-88 104.21 Aug. 84.27 78.36 87.^2 79.12 92.51 89.81 June July 102.46 113.06 107.2s 122. S4 104 . 2( Sept 79. 35 77.26 76.12 85.23 77-46 103 . i5 123. SI II4.6I 120.73 103. s£ Oct 74.25 83.26 75.96 85.77 "Source: Federal Reserve Bulletin, September, 1918, January, 1920, and November, 1920. For course of sever.Tl currencies on the markets of European neutrals see the Bulletin for September, 1917, May, 1918, June, 1919 and November, 1919. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 319 low rates for Swedish kroner in 1920 were 22.15 cents and 17.76 cents as compared with 29.12 cents and 20.50 cents for the year 1919. Danish exchange was about par in January, 1919, and declined almost without interruption throughout the year. In December, 1919, the rate was about 74.2 per cent of parity. In 1920 there was a sharp break in February to about 58 per cent of parity, the rate rose slightly during the next five months and declined con- tinuously thereafter to the end of the year, when demand rates were at about 56 per cent of parity. The high and low demand quotations for the year 1920 were 19.05 cents and 13.00 cents as compared with 26.88 cents and 17.20 cents for the year 1919. Dutch guilders were at a premium of about 2 per cent of parity, which is 40.2 cents per guilder, during February and March, 1919. The decline was less than that of the Scandinavian cur- rencies. At the end of the year guilders were quoted about 95 per cent of parity. The decline during 1920 was continuous and at the end of the year they were quoted at about 75 per cent of parity. The high and low quotations for 1920 were 39.06 cents . and 29.25 cents as compared with 42.57 cents and 36.88 cents for 1919. iii. Currency of the Central Powers (a) From August, 1914 to April, igi'j — Marks were at a slight premium in the early part of the war but declined below par before the end of 1914. During 1915, the decline was practically continuous from a high rate of 92.8 per cent of parity in January to 83.8 per cent in December. During 1916 the rate fluctuated with the military fortunes of Germany. In May the high rate was 82.1 per cent of parity and in November the high rate was 73.7 per cent. At the entry of the United States into the war the mark was at about 75.1 per cent of parity which was relatively lower than francs, though not quite so low as lire or rubles. The course of Austrian kronen is similarly a record of a prac- tically continuous decline from parity at the outbreak of the war to about 54 per cent of parity before April, 1917, relatively the lowest of all the belligerent exchanges. Digitized by Microsoft® 320 mtERNATIONAL FINANCE AND ITS HEOSGANIZATION (b) During the Belligerency of the United States — During the belligerency of the United States trading in German marks and Austrian kronen was suspended in New York. The course of these exchanges must therefore be followed on a neutral market. The reader can construct the hypothetical rates of German marks and Austrian kronen in New York by multiplying the percentage of parity of marks in Switzerland by the percentage of parity of Swiss francs in New York. During January, Febru- ary, and March, of 191 7 the high demand rates for Swiss francs in New York was about 103 per cent of parity. The average of demand rates for German marks in Basle was 68.5, 66.6 and 64.2 per cent of parity during the first three months of the year. The rates of German marks in New York were 75.0, 74.4 and 75.1 per cent. Upon the entry of the United States into the war the monthly average demand rates for marks in Switzerland declined month by month from 64.2 per cent in April, 1917, down to 51.0 per cent in October, 191 7. The armistice with Russia, the Treaty of Movement of Demand Exchange Rates of Marks and Kronen in Switzerland During the Period of the Belligerency of the United States " Based on gold parity as 100 Month Berlin Vienna Month Berlin Vienna 1917 January February March April 68.53 66,62 64.19 64.19 60.83 55.48 SI. 43 51.64 52.49 51 03 52-65 69.46 51.80 48.80 47-71 47-23 46.09 41.42 38-81 38-85 39-52 37.85 38.33 50.00 1918 January February March April May June July August September. . . October November. . . December. . . 67.03 70.27 66.50 64.07 55.89 53-27 55-40 54-65 58-29 SO -81 48-58 50.00 54.76 52.61 50.09 46.42 38.09 37.62 36.16 35-94 40.00 31.16 29.01 Mav June July August September October November December. . . . "Compiled by Federal Reserve Board from Revue Commerciale et Industrielle Suisse, 1914-1918, Federal Reserve Bulletin, September, 1918, and June, 1919, Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR $2t 1 i 1 § 18 S! ^ 5 ; ^ is ft! $ ; 6 a !8 OJ $ ^ ' ^ \ St _ 1 1 1 i 1 5 K ? 1 i 33(1 AON IX) my ^ AJOrS 3Mjr ^ .-■ JW / ^ r / '83J * / ^v ■>.. Mr ■cm AON ^' "^ ^ ^ JtSS Bfiy xini\ yjy ^ I ^ / ^ ^ J f / rf IMT '330 ~ AOU 'JDO ^^ y ,^ 'Jd3S / / my mi% r / / / njy iOil '33J S \ I mr ■:aa~ AON '100 A -^ ,^ , ---• ■* / /\ / IdSS' sny aw 5; ydf will S3J NW ■:aa ■AON r 1 / \ / / r / ,' * ^ \ 1 ' ■"s \ y r \ ■ux\ jnir wnr ^ ^ } > — • r— - If § 58 Si § J i ^ 1^ H ^ ^ S % !8 !H ^ f ^ \ ^ } !S 1 Digitized by Microsoft® 322 INTERNATIONAL FINANCE AND ITS REORGANIZATION Brest-Litovsk, and the successful German offensive in the spring of 1918 all tended to raise the value of the mark. It reached a high level in February, 191 8, when the rate was 70.3 per cent. Thereafter the monthly averages declined with slight interruptions to 54.6 per cent of parity in September, 50.8 per cent of parity in November, 48.6 per cent of parity in December, 1918, and so on down. (c) After July, igig — When trading in enemy exchange was resumed in New York in July, 1919, the high rate for marks during the month was 8.00 cents or about 33.6 per cent of parity. The decline through the rest of the year was continuous and pronounced, and in Decem- ber, 19 19, the high rate was about 11 per cent of parity. During 1920 the rate continued to decline in the early part of the year, rose sharply In May to about 12.3 per cent of parity, maintained that level for the next three months, and declined thereafter to the end of the year. The boom in marks was due to heavy purchases of German securities by speculators. The last five months of the year were characterized by a decline almost to the low level of the year. In December marks were quoted at around 1.30 cents. The high and low demand rates for the year 1920 were 3.01 cents and 1. 01 cents as compared with about 7.00 cents and 2.00 cents for the year 1919.^'^'' In July, 1919, Austrian kronen were quoted at a high rate of 3.50 cents or 17.3 per cent of parity. There was a terrific decline during the rest of 191 9, the high demand rate in December being only 3.6 per cent of parity. This decline was continued and in February of 1920 the rate was about 2.0 per cent. There was a subsequent recovery, owing to speculative purchases by foreigners of Austrian securities as well as to the tendency toward ameliora- tion of the terms of the Treaty of Peace. The high record was reached in June, and there was a subsequent decline. Toward the end of the year Austrian kronen were quoted at about 0.22 cent or about i.i per cent of parity. The course of the rates in New York, Stockholm and Basle is shown herewith. "* New York Times Annalist, Jan. 5, 1920, and Jan. 3, 1921. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 323 Movement of Monthly High Demand Rates of Marks and Kronen in New York Before and After the Period of the Belligerency OF THE United States '^ Based on gold parity as 100 Before 1914 June. . . July... August. September October . . November December 191S January. . . February. . March .... April May June July August. . . . September. October. . . November. December . 1916 January. . . February. . March .... April May June July August. . . . September. October . . . November. December . 1917 January. . . February. . March .... Berlin 100. 25 loi .10 101.89 99.00 93 09 97.16 92.83 91.71 88.50 87-05 87-45 87.05 86.40 86.66 88.50 88.50 86.00 83-77 80.62 81.41 77.07 80.36 82.06 81.01 78.26 76.02 74- S2 74.12 73-73 79.04 7S-04 74-44 75-11 Vienna 100.10 100.34 100.34 97.88 88.03 88.67 86.21 8S-47 78.18 76.60 77-34 74-78 74-78 74-88 76.60 76.60 72.41 69.46 63-65 73-89 64.04 67.09 66.50 65.27 63-05 61.58 59-85 59-11 58-52 66.01 58.08 54-68 56-65 After 1919 July... August. September October. . November December 1920 January. . . February. . March . . . . April May June July August. . . September October . . Berlin 33 30 19 I 13 10 -59 -44 -31 -37 .64 .92 8.61 4-79 6-59 8.19 12-34 11-54 II. 13 9.61 8.52 6.93 Vienna 17.27 14.80 12.95 8.14 4-93 3-60 3.21 1-97 2.71 2. 71 3-75 3-94 3-55 3.01 2.31 2. 17 "Source: Federal Reserve Bulletin, September, 1918, January, 1920, and November, 1930. Digitized by Microsoft® 324 INTERNATIONAL FINANCE AND ITS REORGANIZATION High Monthly Rate of Masks in Stockholm" Based on gold parity as loo Month 1914 July August September. October . . . November. December . 191S January. . . February., March .... April May June July August. . . . September. October. . . November. December. . 1916 January. . . February. . March .... April May June July August September. October. . . November. December. . 1917 January. . February. Rate 100.24 100.41 100.46 100.12 95.62 99-56 98.72 98.32 95-34 92.25 90.00 88.42 90.56 88.54 .89.72 88.99 86.91 81.00 77.96 74.98 72-39 70.87 70.31 71.16 72.11 70.99 70.59 69.86 69.30 66.09 64.68 64.40 Month 1917 March. . . . April May June July August — September October. .. November December. 1918 January. . , February. , March . . . , April May , June July August September October . . . November, December . 1919 January. . . February. . March. . . . April May June July August September, October . . . November. Rate 64.96 59-62 58. II 56.81 52-87 48.66 46.86 44.72 50-62 66.94 69-75 70.31 70.87 67.22 66.09 64.97 57-37 53-44 56.25 66.94 59-06 50.34 49.78 47-81 42.47 38.25 40.78 36.00 29.81 27.28 22. so 19.69 14.62 '"Federal Reserve Bulletin, January, 1920, p. 42. Digitized by Microsoft® PEINCrPLES AND PRACTICE IN THE WORLD WAR 325 Figure XVII The line at 100 represents gold parity and the figures percentage of parity Note: The rise of the silver exchanges was due to the greatly increased exports of the Far East of war goods during the war, and after the armistice of non-military goods the movement of which was restricted during the war and the deferred demand for which accumulated. _ The resulting shortage of silver, wherewith to effect payment of the inter- national balance of trade, caused a, sharp rise in the price. Digitized by Microsoft® 326 INTERNATIONAL FINANCK AND ITS REORGANIZATION 1 1 s ^liasiis^ss^^^^s'^^^^ li ■yjv 01 ■83J ^ •wr •03a •AOU ■JDO •9W xrnr ^ 7mr-^ mif •iuy •ynn ■B3J •nyr 030 •AOU ■uo ■ ■JJ3F WV AW yjy ■JfW •G3J .vvr \\ / ^^ \ ^•■^ r / c > y // •d i^ / / ^ i> / J> .-^* *^ -••- / / /> ' / \ y / / \ / z' /" / I Jo li:! •- -. ^V -V / \ ■>^, \ •n "^•s \ \ / 1 1 \ / \; \ K V ^S / /• /* t '^ ../ / S! iP§§§i§sss%%%aso^^s5 is 1. li 1 ^f M M DO i- &% 1 J3 Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 327 ^1 ^S^5^^§^§S§^S i3 1 1 s i 1 1 i asj '03a ■AOU •JDO vnn' xinr 3mr xm 'yjy VM ■ffij/ 'fjvr via ■MM ■lOO ■wp ■m/ ann imr /(nv ■yjy i/m wr i : I T i 1" ! ; i : f i : !i .' i / — r ii f;- 1 .• ' / \ i 1 i *'•. )' 1 i / /' 1 1 , i -■ ' 1 i // 1 i _..•• / / / / y ^ I i ''^i 1 1 s^ ^5oSS%$^§g§S| I I' S! ^1 XI ^>. XI eg :ll p5 a o an J3 Digitized by Microsoft® 328 INTERNATIONAL FINANCE AND ITS EEOEGANIZATION 1 s i 1 a50S§^$5§5§§S 5 VJf dm 33J uvr vsa AOU ■JOO ws vny xinr iimr Am ■VdV ■HIT ox AOU IM 1 / f I \ } ) 1 / /\ I \ / I — ^ r / 1 i / i i \ 1 1 / 1 1 \ \ \ / \ s I / f i i t / / / / / / / / / J 1 finr 7unp ■H/f •B3J §1 f8S — ■s^ 3 ^.5 b Sa X a B) H 1 0.0 ^^ fi m V J= •S 73 „ B S «T3 &.5 b n C4 V CljO e ■0 5 "S-S wa ^ Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 329 C. The Causes of Exchange Fluctuations Before the war the limited exchange fluctuations were due primarily to commercial factors, such as changes in the volume of exports or imports of commodities or of gold, or to the flow of capital incident to borrowing or lending. But during the war embargoes on the shipment of goods, on the movement of gold, and on the buying and selling of securities warped the exchange rates. In addition fiscal and political factors which affected the likelihood . of resumption of specie payment had an important part in dis- locating exchange rates. i. Commercial Factors (a) Before "Pegging" Sterling — The outstanding commercial factor was the large excess of exports from the United States which increased throughout the war. In the early part of 191 5 this growth in exports was reflected in the decline of all the exchanges on the New York market. (b) During the "Peg"— Sterling was "pegged" in New York through the large borrow- ings by Great Britain and the resale of American securities and the shipment of gold. These factors stabilized the Allied exchanges at an artifically high level. In the free exchange markets of the neutral countries of Europe, the Allied currencies depreciated to their natural level, for the large excess of imports by the Allied countries was not offset by the exportation of gold and securities. It then became profitable to buy the Allied exchanges, chiefly sterling, at their depreciated values in the neutral markets of Europe and to sell them at the higher prices prevailing in the stabilized market in New York. Or neutral dealers could sell sterling in London for dollars and sell the dollars in New York. The resulting abundance of dollar exchange naturally caused its depreciation. During the entire period of our belligerency and until the "peg" was released neutral exchanges were at a premium in New York, as shown above. Erroneous explanations were offered for the appreciation of neutral exchange in New York.^" It was said that "the dollar "Harvard Review of Economic Statistics for July, 1919, "Balance of Trade of the United States," p. 244, footnote t refers to the "unfavorable balance of trade of the United States in the neutral markets." Digitized by Microsoft® 330 INTERNATIONAL FINANCE AND ITS REORGANIZATION went to a marked discount in neutral markets after our entry into the war chiefly because our balances in these countries were un- favorable to us." This explanation is obviously incorrect. After our entry into the war the United States had an excess of exports in its trade with all the neutral countries of Europe except Switz- erland, as shown in the table herewith. It is only in our trade with the South American countries that we had an excess of imports. FoEEiGN Trade of the United States with Certain Foreign Countries ^i Excess of exports (+) or of imports (— ) (in million dollars) Country T9I3 1914 191S 1916 1917 igiS 1919 United Kingdom . France Italy Russia Denmark Sweden Norway Netherlands. . Spain Switzerland. . Germany. Austria... Argentina . Brazil Chile +3" -9 + iS.o + 23.3 + .36 + 16. 1 + 1.7 + 0.8 + 83.9 + 6.4 — 23-5 +167.7 + 3-1 + 29-4 — 6r.o — 12.9 +304-9 + 6s. 9 + 42-7 + 10.0 38.1 19.2 + 7-7 -- 63.2 + S.8 — 20.7 + 8.9 — 2.9 — 29.1 — 71.7 — 10.6 +888.8 +422.9 +218.2 +123.4 + 70.8 + 73.9 + 39-2 +114. S + 27.0 — 13-9 — 33-2 — 5-2 — 41.8 — 86.1 — I9-S +1498.2 + 7SI-9 + 243.3 + 30s -3 S3 -3 29.1 59-8 70.1 31-7 8.8 IS86.2 • 842.2 ■ 382.6 ■ 302.9 31-4 2.4 ■ 56.6 ■ 30.0 S4-7 ■ 04 — 3-6 — 0.6 — 39-4 — 84.4 — 48.7 0.2 — 0.1 71.2 79-1 85.0 +1834-4 + 871-7 + 467.8 + 2.1 + 10.6 9-7 34-1 2-5 SO. 7 10.7 0.3 o.r 123-3 — 40.6 — 99-7 +1857. S + 769-5 + 383-6 + 27-3 + 157-8 + "9-3 127.8 179-6 53-3 48.5 82.2 39-8 — 43-3 — 118. 9 — 29-3 The correct explanation °^ is that the neutral currencies appre- ciated in the New York market because the United States bought more of the neutral currencies from Great Britain than it sold to Great Britain, and because the neutrals sold more sterling in New York than they bought there. In other words, because of the inter-Allied financial unity the aggregate of Allied exports was less than the aggregate of Allied imports. This will be treated more fully in the discussion of the mechanism of stabilization of exchange. The appreciation of the Scandinavian exchanges in New York was due in part to the large credits due the Scandinavian countries on account of shipping. Norway's credit on this account amounted to 120 million kroner in 19 10, about 220 million in 191 3, about 475 million in 1915, and to 1063 million kroner in 1916.^* " Statistical Abstract, 1919. "Report of the Federal Reserve Board for the year 1918, p. 53, et seq, ■' Stavanger Aftonblad, June 14, 1918. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 33 1 Another factor in raising the New York exchange rates of the European neutrals was the restriction by neutrals on gold settle- ments. For instance, although at parity a dollar is equal to 5.18 pesetas, the Bank of Spain refused to accept American gold at more than 5.03 pesetas. This discount on gold in Spain accounts for part of the premium on pesetas in New York. Again the Scandinavian countries at first purchased gold at a discount of about 5 to 6 per cent and subsequently put an embargo on gold imports. The acute shortage of goods in the neutral countries of Europe caused a rise in prices which was aggravated by the increase in the quantity of gold. The desire to avoid this so-called gold Inflation accounts partly for the appreciation of the neutral exchanges. The theory of the neutrals in both cases was that their credits ought to be settled by imports of merchandise. (c) After the Release of the "Peg" — Upon the discontinuance of the stabilization of sterling exchange in the New York market the normal play of economic forces again became apparent. The United States had a large excess of exports, embargoes on goods were removed, gold was again free to flow, and the currencies of the European neutrals fell to an ever-increasing discount. Only the South American currencies, as shown above, temporarily maintained their premium in the New York market. The reason was obvious. The United States had an excess of imports from these countries. ii. Fiscal Factors The commercial factor accounts for the daily variations in exchange rates. A large offering of bills may cause a violent break in the market. But exchange rates also respond, though not so sensitively, to the depreciation of the currency. To use an analogy, the currency factor corresponds to the climate, the com- mercial factor corresponds to the weather. Usually both the com- mercial and the currency factors produce the same results, for during a period of borrowing or excessive issue of paper a country usually has an excess of imports. During and since the war the countries of Europe lacking raw materials have had a large excess of imports, and at the same time a depreciating currency. If these countries had increasing exports the currency situation would Digitized by Microsoft® 332 INTERNATIONAL FINANCE AND ITS REORGANIZATION gradually improve. This condition obtained in the United States after the Civil War.^* However, sometimes the two factors operate in opposite directions. For instance, during the period from March to April, 1920, German exchange was rising on all the markets of the world in spite of the fact that the circulation of banknotes increased from 48 to 56 billion marks. But this was due to a peculiar condition. The depreciation of exchange rates, however. Is not an accurate measure of the decline in the ratio of gold to notes. Following are the figures for Germany: Date Ratio of gold to total note issues Rates of exchange cents per mark June 30, 1920 June, 1914 Ratio of post-war to pre-war figure 1 . 4 per cent 59 . 6 per cent 2 . 4 per cent 2.65 23.80 II. I per cent A comparison for France shows a similar result. Date Ratio of gold to total notes Rates of exchange cents per franc November 11, 1920. June, 1914. Ratio of post-war to pre-war figures . . . 8 . 2 per cent S9 . S per cent 13 . 6 per cent 5-88 19.30 30. S percent The exchange rates, depreciated as they are, do not measure the full extent of note inflation. External depreciation is less than inflation of currency. This difference may be due to the fact that the large volume of gold before the war could have been reduced considerably without impairing the convertibility of the paper money. Theoretically if visible and invisible imports balanced exports exactly and if gold flowed freely the depreciation of exchange rates would equal the premium on paper money. The fiscal causes of exchange depreciation are closely connected with the commercial causes. Fiscal factors, such as the issue of notes "* Hepburn, A, B., History of Currency, 1915 ed., pp. iz6, zzj. See also Mitchell, Wesley C, History of Greenbacks. Digitized by Microsoft® PSINCIPLES AND PRACTICE IN THE WORLD WAR 333 by the state, and monetary factors, such as the free circulation of gold coins regulate relative international price levels in gold. Relative price levels determine the flow of trade. As noted above, a regime of inconvertible paper usually follows a period of heavy foreign borrowing and of inflation of the currency. Such was the case both in Argentina in the latter half of the nineteenth century and in the belligerent countries of Europe during the World War. The correctives of exchange, discussed above, apply chiefly when depreciation is due to commercial factors. iii. Political and Other Factors There are other causes of exchange fluctuations. The fortunes of war had a decisive effect. When the United States entered the war in 19 17, francs and lire rose on the world markets but marks and Austrian kronen declined. In the fall of 1917 the successful Austrian campaign against Italy, followed shortly by the complete defeat of Russia and Rumania by Germany, led to a sharp rise in German and Austrian exchange. The signing of the Treaty of Brest-Litovsk and the German offensive in France in the spring of 191 8 maintained these exchanges at a high level until the summer. The spirited fighting of the fresh American troops, the turning of the tide at Chateau-Thierry, and the successful counter- offensive by Foch marked the beginning of a rapid and continuous decline of these exchanges. From a quotation of about 70 per cent of parity in the spring of 1918, marks fell to about 50 per cent at the signing of the armistice. Austrian kronen fell from a quotation of about 55 per cent of parity to about 31 per cent in the same period. Similarly the neutral exchanges declined in New York upon the entry of the United States into the war and likewise declined very rapidly from their high levels in the summer of 191 8, follow- ing the successful offensive against the Germans. In this period the premium on Swedish kroner declined from about 37 per cent to about 7 per cent, Dutch guilders from a premium of about 28 per cent to 3 per cent, and on Swiss francs from about 31 per cent to 3 per cent. Other factors influencing exchange rates were tke adoption of measures to increase taxes and other revenue, the flotation of war loans, the increase of note issues, the gain or loss in gold, Digitized by Microsoft® 334 INTERNATIONAL FINANCE AND ITS REORGANIZATION in short all events of political or social importance, including rumors and psychological factors which affect the future balance of trade, and the convertibility of the depreciated paper. D. The Effects of Depreciation of the Foreign Exchanges The depreciation of the foreign exchanges causes instability of trade. Some economists have held that both commercially and financially a falling exchange tends to correct itself. Others have held the opposite view. The difference of opinion, however, is reconcilable because the two opposite effects observed are due to two separate sets of causes. i. The Self-Corrective Effect of Depreciation (a) Commercial Self-Correctives — I. Exports are fostered — A depreciated exchange tends to foster a country's exports and to check its imports. For instance, the decline of Danish exchange in New Yoric after the release of the "peg" caused a heavy shipment of butter, eggs and potatoes from Denmark to the United States in spite of the fact that all of these foods were in great demand in Central Europe. Danish exchange stiffened as the result of the demand to pay for the imports.^' Similarly Spanish onions, Asiatic peanuts, Irish potatoes and cabbage from the neutral countries of Europe began to com- pete with the American products owing to the decline in exchange in the early part of 1920. Again, in competition with both Bel- gium and Great Britain, Germany was a successful bidder on a large French order for locomotives, in spite of the fact that the French would have preferred to trade with their former Allies.^® The decline in German exchange on the French market gave the German exporter a temporary bounty which stimulated exports and thus tended to correct the falling mark. The fall of the mark in the autumn of 1919 and in the early part of 1920 brought a host of foreign buyers into Germany to take advantage of the so-called "clearance sale." The heavy exports tended to check the fall and in the spring of 1920 the mark rose, owing in part probably to the increase of exports (and in part to the speculative purchases of German securities by foreigners). '" New York Times, January 3, 1920, and December 9, igao. "Journal of Commerce, December i, 1920. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 335 The self-corrective effect of the declining exchanges of Europe led to legislative proposals. For instance, the woolen manufac- turers, testifying before the Ways and Means Committee of the House, ^^ proposed measures to prevent the falling exchanges from correcting themselves. A law was recommended to "normalize exchange by levying a tax of the difference in cost between goods imported under theicurrent and under the normal rate of exchange." The law contemplated assessments not at the depreciated rate but at the normal rate of exchange. Furthermore, to prevent dump- ing of foreign goods, whether dutiable or not, the federal govern- ment was urged to collect an "equalizing charge" or the difference between the amount payable at the current rate of exchange and at the normal rate. This petition is similar to that of the associa- tions of Swedish and of Swiss industries to the respective Ministers of Finance for protection against the competition of German manufacturers who were favored by the depreciation of the mark. 2. Imports are checked — ^The decline of the exchanges on the New York market led to a restriction of imports into the several countries from the United States. The Association of Boot and Shoe Manufacturers of Brazil passed a resolution to discontinue imports of leather from the United States until the American dollar declined to parity, or the Brazilian milreis rose to parity.^* Again, the depreciation of the Canadian dollar in the United States induced curtailment of Canadian purchases in the United States. The Canadian Wholesale Grocers' Associa- tion favored the discontinuance of purchases in the United States, and the Board of Trade, the bankers', wholesalers' and consumers' organizations of Winnipeg urged discrimination against American products to reduce Canadian imports in order to raise the level of the Canadian dollar in the New York market. At the same time they advised a preferential for British goods because of the depreciation of sterling.^® The depreciation of Belgian exchange checked imports from the United States and to a less extent from Great Britain, and stimulated imports from Germany.^" "December 8, 1920. "Journal of Commerce, December a, 1920. " Associated Press despatch, Toronto, February 7, 1920, and Winnipeg, February 6, 1920. "Report of Trade Commissioner C. E. Herring, Commerce Reports, October 29, 1919. Digitized by Microsoft® 336 INTERNATIONAL FINANCE AND ITS REORGANIZATION 3. ExPLANATlON"^What is the explanation of this phe- nomenon ? Is it that the depreciation of the exchange of a country acts as a bounty to its exporters and a burden to its importers? This would be true if the price level within the country were no higher than when exchange was at parity. A truer explanation IS that the depreciation of exchange rates keeps pace with the rise in the price of gold but that the general price level lags behind. As a result the exporter from a country with depreciated exchange buys at the general price level, and sells to the foreigner at the equivalent of a higher price level. The profit to the exporter arises from the re-conversion of the foreign stable currency into his own depreciating currency. Naturally the demand for goods for export tends to make prices rise and until the general price level reaches the export price level a profit on exchange accrues to the exporter. But the depreciation of the exchange of a country raises the price in its own paper money of imports of food and raw materials, therefore wages and other costs of production subte- quently rise toward the world level and this profit to the exporier diminishes. The equalization of price levels eliminates the seH- correctives. Until the stage of equilibrium is reached the fall, of the exchange is a burden upon the less mobile factors in the cost of production, such as rent, overhead, and most of all labor. That is, the lag in the rise of wages below the rise in cost of living, which depends upon imported goods, constitutes a profit to the exporter, but a burden to the wage earner. {b) Financial Self-Correctives — j,- The depreciation of the exchange of a country is a financial self-corrective as well. It induces the resale of its holdings of securities of other countries whose exchange is not depreciated. For example, when sterling depreciated in New York, English- men resold their holdings of dollar securities and obtained more sterling than they loaned. Of course, if the securities were pay- able not in dollars but in sterling this effect would not be evident. Before the United States entered the war this method of correct- ing the declining exchanges of the Allies was in effect. As shown below about 56 per cent cent of the British holdings of American railroad securities were liquidated in New York between January, " For fuller discussion see article by John H, Williams, Annals of the Academy for Political and Social Science, May, 1920, pp. 200, et seg. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 337 1915, and January, 1917. During the period of our belligerency the United States government advances eliminated the need for such a corrective. But after the release of the "peg" the deprecia- tion of sterling in New York induced another wave of selling, whereby Britishers obtained a premium on the sale of the inter- national securities, the stocks and bonds listed on both the New York and European stock exchanges. As a result of the pressure of sales by foreigners in the New York market, many common stocks which had a long unbroken record of dividends sold at far lower prices in 1920 than at quotations during 19 14 or even the week prior to America's entry into the war. The depreciation of exchange of a country tends to make ft borrow in those countries whose exchange is at gold parity. THe heavy borrowings during 19 19 and 1920 by the countries of Europe, both belligerent and neutral in the World War furnish ample evidence of this tendency. As the depreciation of exchange is wiped out the borrowers profit on the operation, provided the loan was made in the currency which remained at gold parity. Further- more, the investors of a country whose exchange is at gold parity are induced to buy the securities or the currency of a country where exchange is depreciated in the speculative expectation that exchange will rise and give the investor a larger return upon reconversion into his own currency. Similarly these investors will leave their bank deposits in the country whose currency is depre- ciated, and will sell their foreign holdings, bank deposits and short-term bills as the depreciated currency rises. This selling has the effect of checking a rise. This result may be minimized by con- verting the holdings of currency or of short-term bills into long- term bonds, whose maturity date is fixed beyond the period when the exchanges are likely to be in acute depreciation. ii. Denial of the Self-Corrective Effects of Depreciated Exchange (a) Commercial — There are economists who hold that a depreciating exchange does not tend to correct itself. J. M. Keynes did not find that a depreciated exchange acted as a bounty to British Indian exporters. Again, after the World War the depreciating exchange in Ger- many not only did not check imports but it stimulated imports, even of luxuries. The champagne purchases during 1920 were Digitized by Microsoft® 338 INTERNATIONAL FINANCE AND ITS REORGANIZATION the largest in the history of Germany. The Minister of Finance Herr Wirth, bewailed the huge imports of chocolates, wines and other articles of luxury. This extravagance, however, affected not only imports but also articles of domestic production. Whether as a result of five years of abstinence and restraint or of the rapidly diminishing purchasing power of the mark, luxuries were consumed in great quantities and display was rampant. Again, even in Great Britain the relatively small depreciation of sterling did not check imports, because after all the largest share of the imports consisted of goods needed. The effect of depreciating exchange then is merely to increase the cost of essential imports. Again, it is held that depreciating exchange does not stimulate exports, because as the exchange depreciates prices within the county likewise rise to the world price level and thus eliminate the differential. (b) Financial — There are similar denials that a depreciating exchange tends to cause borrowing abroad or the resale of holdings of securities of countries whose currency is at gold parity. According to news- paper despatches'^ French investors did not sell dollar securities in order to get more francs as the market depreciated, and thus by selling dollars or buying francs to correct the exchange. Instead it was said that they bought dollar securities, and sold francs on a rapidly depreciating market. Similarly the so-called "flight of capital" from Germany, while it may have been induced by oppres- sive tax measures, was in part due to the rapid decline in value of the German mark. Germans sold marks on the declining market and bought the currencies of neutral countries and of the United States in order to arrest the continuous diminution of their wealth. The marked decline of the Austrian kronen led to panic sales of kronen and to the purchase of foreign securities. As a result the depreciated kronen declined still further.*' The purchase of foreign securities is not confined to the countries where the cur- rency is greatly depreciated. Even Dutch investors, small farmers as well as city capitalists' bought American currency and securi- ties.'* "Associated Press, March 22, 1919, " New York Times, December so, igao. "Dispatch to New York Times, November 9, 1920. Digitized by Microsoft® PEINCIPLES AND PRACTICE IN THE WORLD WAR 339 iii. Reconciliation of the Apparently Conflicting Facts (a) Commercial vs. Fiscal Causes of Depreciation — ■ The two tendencies, though apparently contradictory, are recon- cilable. If the depreciation is due to an excess of imports a decline of exchange undoubtedly has an effect on trade. It checks imports and stimulates exports. Likewise, the financial eflect is to stimulate borrowing in the country whose exchange is at or near parity and reselling to that country of the securities issued in the stable cur- rency. If however the depreciation is due to a rapid increase in the volume of the currency then the opposite effects are noted. Imports, particularly of luxury articles, are accelerated. A depreciating currency fosters extravagance because holders wish to get rid of it before it rots on their hands. They convert it into anything which depreciates less rapidly. No distinction is made between domestic goods and foreign goods. A similar finan' cial effect follows. Holders of a rapidly depreciating currency will invest it in diamonds bought at home or in securities bought . abroad, or in any value, domestic or foreign which will not waste away as rapidly as the depreciating currency. These anomalous phenomena are in part due to the fact that gold is not publicly and freely quoted in terms of depreciated paper, and that the flow of gold as a corrective of the exchange is restricted. The wide fluctuations of exchange, the unsettlement of trade, and the failure of a depreciating exchange quickly to correct itself are the price that the governments of Europe are paying for the failure to recognize a premium on gold and to permit gold to flow freely. (b) Relation Between Fall of Exchange and Rise of Prices — The fall in exchange rates bears a close relation to the rise in internal prices. The foreign exchange value of the depreciated currencies and the rise in domestic prices both indicate the lowered purchasing power of paper money. The foreigner as well as the native makes a guess as to the diminution in value of depreciated paper money. The experts at the Brussels Financial Conference prepared a table to illustrate the relation between exchange rates and prices. Since the United States is a free gold market, prices in the United States may be regarded as gold prices. The United States index number of 19x3 is taken as a basis of lOO. The Digitized by Microsoft® 340 INTERNATIONAL FINANCE AND ITS REORGANIZATION tfttV Figure XXI Movement of Foreign Exchanges on New York and of Commodity Prices in Four Countries Prices, above heavy line, based on 19x3 average as 100. Exchange rates, below heavy line, in terms of depreciation from parity Digitized by Microsoft® P&INCIPLES AND PRACTICE IN THE WORLD WAR 341 PERCE^^• tePRECIACriOH "ii^-j^z^iri; DraiANGE_^ F^==^ \^yy^ ■""■^ PURCH aiNO POWER F CURRENOy ^ v"^ r^ ENGLAND 1917 1910 1919 1920 1921 Figure XXII Depreciation of Foreign Exchange from Par and Depreciation of the Purchasing Power of Foreign Currencies from the Purchasing Power of the Dollar The zero line represents the value of the dollar and the figures for ex- change and purchasing power are plotted as percentages below full dollar value Digitized by Microsoft® 342 INTERNATIONAL FINANCE AND ITS REORGANIZATION relative cost of dollars in foreign currencies is based on gold parity as ICO. The external price index of the several countries obtained by multiplying the gold price index in the United States by the relative cost of the dollar in the foreign currency, gives the relative cost in foreign currency of American commodities. For com- parison, there is given the domestic price or the cost at home in :he native currency, using the 1913 index number of each country as a base of 100. The table indicates that both the domestic price level and the depreciation of the exchange rates reflect proportionately the depre- ciation of the currency. Differences existing between them may be due to the differences in the constituents of index numbers, the hoarding of notes, etc. Comparison op the Domestic PuRCHAsrao Power of Certain Currencies AND Their Purchasing Power in the United States '* Country United States index number. 1913 = 100 Relative cost of dollars in foreign cur- rency. Parity= 100 (6) External price. Cost in for- eign curren- cies of com- modities in United States. 1013 = 100 w= (o)X(i)-Moo Internal price. Cost at home in native currency. 1913=100 December, 1919 Italy, lire France, francs United Kingdom, sterling Sweden, kroner Canada, dollars . . . Japan, yen May, 1920 Italy, lire France, francs United Kingdom, sterling Sweden, kroner. . . Canada, dollars. . . Japan, yen 238 238 238 238 238 238 26s 265 26s 26s 26s 26s 256 210 129 I2S 108 99 424 319 126 log 100 609 499 308 298 2S8 23s 1124 84s 334 331 289 26s 457 425 277 317 238 289 679 SS3 313 3S4 261 301 "Currency Statistics, Paper III of the Brussels Financial Conference, Table 5, p. 41. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 343 The tables show that the countries ranged in series under column {c) would correspond to a series under column (d). The country with the highest rise of internal prices likewise shows the greatest depreciation of exchange. In general external prices rise higher than domestic prices where gold does not flow freely. This means that the exporter who bought at the domestic price level and sold abroad at the higher foreign price level enjoyed the so-called "bounty" resulting from depreciating exchange. However in the two countries, Japan and Sweden, which did not restrict the movement of gold after the war, external prices rose less than internal prices. Or the depreciation of exchange rates was less than the decline of the purchasing power at home, iv. The Unsettling Effect of Unstable Exchange Rates (a) Commercial — The rapid and extreme fluctuations of exchange made foreign trade operations highly speculative. To eliminate the element of unstable rates, traders reverted to barter. For instance, France, traded coal from the Saar Basin for a variety of German products. Similarly Belgium and Rumania traded coal for corn. Great Britain and Czecho-Slovakia traded coal for enamelware. In these transactions no monetary unit was taken into account, a specific quantity of one commodity was exchanged for a specific quantity of the other. Raw materials were also bartered for the resulting finished goods. This so-called "refining trade" was part of a credit scheme under which raw materials would be shipped to Germany. The foreigner furnishing them would retain a lien on the goods in process which became increasingly valuable and thus added to the security. (b) Financial — The depreciation of the foreign exchanges in New York unsettled the international market for securities. As the exchanges of the countries of Europe declined their internal loans held in the United States fell in value. Interest in the depreciating cur- rency was collectible in dollars only at a considerable loss. In many cases it was not immediately converted into dollars but remained as a floating debt, usually converted on a temporary Digitized by Microsoft® 344 INTERNATIONAL FINANCE AND ITS REORGANIZATION rise in the exchange market and thus checking the improvement. The risks of further declines in exchange discouraged American investments in internal loans of the European governments. To avoid this difficulty foreign governments floated loans at high rates of interest, payable in dollars, or in a few cases payable at the option of the holder either in dollars or in the foreign currency, at a graduated percentage of the improved value of the exchange, V. Tke Increased Importance of Dollar Exchange Dollar exchange increased in importance because the United States became now the chief free gold market of the world. Therefore the depreciation of the exchanges in New York was a measure of the discount on paper money or the premium on gold. (a) Wider Arbitrage Transactions — Before August, 1914, the arbitrage operations of American dealers in foreign exchange were confined practically to the three principal currencies of Europe, sterling, francs, and marks. Other exchange was purchased almost entirely through London. Since the war American dealers in foreign exchange have conducted arbitrage operations with practically every country in the world. (b) Development of Dollar Exchange '" — Another indication of the growth of dollar exchange is the huge volume of transactions in dollars. From February 20, 191 8, to December 31, 1918, the dollar exchange furnished on Allied account amounted to $26,000 million, due chiefly to United States government loans. The aggregate debits and credits in dollar exchange operations with European countries, other than the Allies, was about $2500 million, with countries in Asia $2800 million, with countries of South America $1900 million, with Central America, Mexico and the West Indies $2300 million. Many countries bought goods in the United States with dollars accumu- lated here rather than with sterling, as before the war. Many of these transactions represented the purchase and sale of securities in the United States for the account of foreigners. Furthermore, as the neutral countries accumulated balances in the United States which could not be liquidated through the exportation of gold during the embargo they purchased foreign securities, chiefly "Annual report of Federal Reserve Board for the year 1918, p. 56. Digitized by Microsoft® PEINCIPLES AND PEACTICE IN THE WORLD WAR 345 British. Purchases of securities in the United States for foreign account in the ten months ending December 31, 1918, totaled about $400 million, and the sales for foreign account about $350 million. The excess of purchases over sales were of American, British and French securities. At the end of the year the securities held in America for foreign account amounted to $i8cx) million and the securities held abroad for American account amounted to $97 million. E. The Correctives of Foreign Exchange The several factors which tend to correct depreciated exchange, according to economic theory, were operative during the war. From January, 1915, to June, 1917, Europe shipped gold to the United States aggregating $1255 million. Again, Europe resold to the United States securities which had been exported before the war. The amounts resold were estimated at about $2000 million. Again, loans both secured and unsecured amounting to about $2800 million were raised by the Allied Powers to pay for their excess of imports and thus to correct their exchanges. Finally, after April, 191 7, the United States government extended advances totaling about $9500 million. To help control the daily fluctua- tions in the market a fund of about $50 million was made avail- able in London by a group of New York bankers. ^ i. Commodity Movements (a) During the War — After the entry of the United States into the war it became necessary to maintain the purchasing power of the Allied govern- ments in the United States, and in the neutral markets of the world. Although the United States Treasury did not take any steps in the actual support of sterling, francs and lire in New York it maintained a sympathetic attitude toward the "pegging" operation. As a result of inter-Allied financial unity the excess of exports of the United States was no longer the chief factor in determining the position of the dollar on the markets of the world. The Allied and Associated Powers, the United States, Great Britain, France, and ifely, had effected a financial unity and their several exchanges were determined no longer by the factors affecting each individual country, but by the sum total Digitized by Microsoft® 346 INTERNATIONAL TINANCE AND ITS REORGANIZATION of the international debits and credits affecting the entire group. The dollar depreciated sympathetically with the Allied currencies. Normally the exchanges would have corrected themselves by stimulating exports and checking imports. But commercial con- siderations had to yield to military necessity and as a result the normal correctives were not operative. The need for shipping facilities in the Atlantic lanes, the blockade of the Central Powers and of the neighboring neutrals, made international trade settle- ments difficult. As a result of the inter-Allied financial unity the balancing of their international debits by means of exports was equally effective in stabilizing dollar or sterling exchange, whether these exports were made by the United States or by any Allied power. But the need for tonnage to carry war supplies from the United States made it difficult to provide additional shipping for non-military supplies to those European neutrals that had no tonnage of their own. Although the Allied powers were importing vastly more than they were exporting and there- fore they had ample tonnage for such exports as they were able to make, yet the blockade of the enemy powers restricted exports to the neighboring neutrals. On the other hand exports to distant parts of the world was made difficult by the general shortage of tonnage."^ Therefore, the flow of commodities could not correct the depreciated exchange of the Allies. (b) After the War— The release of the "peg'' disrupted the inter-Allied unity. As a result the monthly returns for the powers that had a large excess of imports during 19 19 showed a gradual decrease during 1920. The excess of imports from the United States into four formerly belligerent countries of Europe for the years 1913, 1918, 1919 and 1920 was as follows: Excess or Imports prom the United States (in million dollars) Country 1920 1919 1918 1913 United Kingdon. France Italy Belgium 1311 296 23s 1969 770 384 370 1Q13 872 468 I5S 319 IS 23 23 " Report of the Secretary of the Treasury for the year 1918, p. 38. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 347 When the United States loans were discontinued the nations of Europe could no longer settle for their excess of imports by borrowing. They had to settle for it by exports. And in a large measure they did. ii. Flow of Gold (a) Prior to the War — A study of the balance of trade of the United States shows that gold flows into a country in settlement of its international credits, and that gold flows out of a country in settlement of its international debits. The gold flow, however, does not exactly balance the flow of commodities. Other relevant factors are shipping, interest on invested capital, and the minor items in the international balance. The Balance op Shipments op Merchandise and Gold's (in million dollars) Period Excess of Merchandise Excess of Gold Exports Imports Exports Imports 1821-1837 34 2493 9262 i8s 1541 1098 202 37 36 18^8-1840 1850-1873 1874.-180 1; 174 If the only factors in international trade were merchandise and gold, an excess of exports of merchandise would be balanced by an excess of imports of gold. However, in the period 1821-1837 our net imports were more than offset by our shipping earnings, therefore our international balance on this account was liquidated by net imports of gold. In the period 1838-1849 net merchandise exports were offset by net gold imports, and in the following period merchandise imports were offset by gold exports. In the period 1 874-1 895 there was an excess of exports of commodities and instead of net imports of gold we had net exports, which paid for interest and principal of the growing debt of the United States to Europe. In the period 1895— 19 14 there was a very large excess of merchandise exports and only very small offsetting net gold " Balance of Trade of the United States, by Bullock et al. Digitized by Microsoft® 348 INTERNATIONAL FINANCE AND ITS REORGANIZATION imports, the difference being settled by debits of the United States for services, such as shipping and banking, by immigrants' remft- tances, and by the expenditures for travel of growing numbers of Americans. (b) Flow of Gold During the War — The imports and exports of gold, both by years and by months during the period 1 914- 1 918 are particularly significant in connec- tion with the exchanges. United States Gouj Movements by Yeaeb " (in million dollars) Year Exports Imports Excess of exports Excess of imports Fiscal year: 1914 191S 1916 1917 Total July 1, 1914-June 30, 1917 1918 Calendar year: 1918 1919 1920 Totals from Aug. i, 1914 — To Nov. 10, 1918 To Dec. 31, 1918 To Dec. 31, 1920 112 146 90 292 67 171 494 977 45 25 404 68s 640 190 41 368 322 703 70s 1395 1709 124 62 76 429 1773 1776 2282 45 66 292 1114 21 107 1070 1071 886 I. Before the belligerency of the United States — For the purpose of studying the flow of gold the period of the vrar must be divided into two, namely : the period before the century of the United States and the period of its belligerency. From July I, 1914, to June 30, 191 7, three fiscal years, the United States imported net $1114 million in gold. The gold came from Europe, chiefly the belligerent Allies who had to settle for their excess of imports not only with the United States but also with the neutrals of Europe. These countries, like the United States, also had large net gold' imports. "U. S. Statistical Abstract, 1919. Federal Reserve Bulletin, November, 1940. Digitized by Microsoft® PRINCIPLES A^RD PRACTICE IN THE WORLD WAR 349 Monthly Gold Movements in the United States Showing Net Excess OE Imports and Exports (in million dollars) Source: Monthly Summary of Foreign Commerce, December, 1914-1919 Month Net Excess of- Exports Imports 1914 Net Excess of- Exports Imports 191S Net Excess of- Exports Imports 1916 January February March April May June July August September October November December Total Year's excess January February March April May June July August September. . . . . October November December Total Year's excess IS 44 30 IS 19 44 7 180 164 16 1917 42 27 27 7 4 2 114 38 S2 122 IS 24 281 167 12 2S IS 30 5° IS 60 40 77 S7 34 421 421 1918 3 29 33 21 14 IS 114 53 -29 86 90 21 131 S44 S30 1919 I 57 S3 43 28 39 49 33 304 292 Digitized by Microsoft® 35° INTERNATIONAI, FINANCE AND ITS REORGANIZATION After the entry of the United States into the war, the govern- ment advanced credit to the Allies. These advances obviated the need for further gold imports from the Allied Powers in settle- ment of huge balances of exports from the United States. During the stabilization of the Allied exchanges, the neutrals of Europe tried to settle their debits against the Allied Powers in the New York exchange market. As a result the neutrals were able to draw gold from New York in settlement of their excess of exports to the Allied Powers. During the three months July, August and September, 1917, the neutrals withdrew about $IOO million in gold from New York, and thus compelled the United States to declare an embargo on gold exports. 2. The flow of gold under the embargo — ^The flow of gold to New York, which had been fairly continuous until the early months of 1917, slackened then. The Allied Powers had exported so much gold in settlement of their adverse balances of trade that they restricted the movement of gold, and thereupon gold withdrawals for Allied account narrowed down to the United States market. Because of. the resulting heavy withdrawal of gold the President on September 7, 191 7, issued a proclamation that "except at such times and under such regulations and subject to such limitations and exceptions as the President shall prescribe and until ordered otherwise by the President or Congress the following articles, namely: coin, bullion and currency, shall not on and after September 10, 1917, be exported from, shipped from or taken out of the United States or its territorial possessions."" The Federal Reserve Board issued regulations and considered applications governing the exportation of coin, bullion and cur- rency. Travelers leaving the country w»re permitted to take with them United States paper currency, other than gold or silver cer- tificates to the amount of $1000 per adult, $100 in silver coin in lieu of an equal amount of notes, and gold coin or gold certificates to the amount of $200. The prime reason for the regulations was the belief that United States currency taken into foreign countries by travelers would be absorbed by enemy agents for propaganda purposes.*^ Applications for the shipment of gold to the neutral countries of Europe were refused. However in order to obtain "Report of the Federal Reserve Board for 1917, p. 20. "Annual Report of the Federal Reserve Board for 1918, p. 36. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 351 necessary raw materials from Mexico, South America and the Far East the Board granted permission to ship gold if the imports were essential to the prosecution of the war. In other words, military and not commercial considerations determined the flow of gold. The embargo on gold removed one of the important correctives of the exchanges and as a result there was a marked depreciation of the dollar on those markets with respect to which the embargo was rigidly enforced, and which held large balances of Allied exchange. Again the embargo increased the gold reserve, and eased the credit situation in the United States. The resulting great expansion made the later deflation in 1920 very acute. The embargo restricted the movement for the extension of American banking abroad. Of course American trade was restricted. These, however, were minor considerations in view of the one outstanding need, a military victory. The net exports during the period of the embargo from October, 191 7, to May, 1919, were only $18 million. The gross exports of coin, bullion and currency under licenses granted by the Federal Reserve Board from September 7, 1917, to June 7, 1919, amounted to about $863 million. Gold $152,326,976.37 Silver 502,756,003.44 U. S. currency 166,780,636.72 Currency of the country to which exported. . . . 28,762,254. 27 Other currency 12,627,800.05 Total $863,253,670.85 Of the total amount of gold licensed $48 million was exported to Mexico, $17 million to Argentina, $16 million to Chile, $13 million to Colombia, and lesser amounts to Venezuela, Peru, Spain, India, Java and Japan. Of the total amount of silver licensed $339 million was exported to India, $62 million to China and lesser amounts to Great Britain, France, Canada and Mexico. Of United States currency licensed $49 million was exported to France, and lesser amounts to other countries. (c) The Flow of Gold After the War— I. Lifting of the embargo — On March i8, 1919, Great Britain ceased to support franc rates in London. On March 20, Great Britain instructed J. P. Morgan & Company to cease sup- Digitized by Microsoft® 3 52 INTERNATIONAL FINANCE AND ITS REORGANIZATION porting sterling in New York. A few days later the support of lire in New Yorlc was abandoned. These steps relieved the pres- sure which was being exercised on New York by the neutrals who had exchange of the Allied Powers to sell. The removal of the "peg" tended to restore the normal conditions under which each country settles for its own trade balances. Accordingly the Federal Reserve Board announced that after May 6, 1919. licenses for gold exports would be granted freely, and that after June 9, 1919, the control of exchange and the embargo on gold would be terminated with minor exceptions. The embargo on gold ex- ports to Bolshevik Russia was lifted in December, 1920. 2. The effects of the lifting of the embargo — ^As a result of the lifting of the embargo there was a very large outflow of gold during the rest of 1919, averaging about $40 million per month. From June to December $290 million in gold were ex- ported in settlement of the huge balances against us which had ac- cumulated in the neutral countries. Prior to the removal of the "peg" the neutrals had exchanged their sterling, francs, and lire for dollars, which they held in the expectation of getting gold. Again, a large portion of this gold was sent to South America and the Far East to pay for imports, which were restricted during the war but which were greatly needed in the United States. Because of this accumulated demand the United States had an excess of imports in its trade with South America and the Far East. From January I, to November 10, 1920, the net gold imports were small, about $107 million, although the gross exports totaled over $428 million. The imports of gold came chiefly from the countries in the trade with which the United States had an excess of exports. During 1920 the United Kingdom shipped in gold $275 million, Canda $35 million, France $49 million. Our outflowing gold was exported to the countries in the trade with which the United States had an excess of imports. Argentina received $90 million, Japan $101 million, China $28 million. Much of the gold imported into the United States was en route to foreign countries to pay the debts of the country from which the gold came originally. France, Italy and Great Britain shipped gold from the United States to settle for their excess of imports from other countries. The United States thus lost gold not only on account of its own excess of im- ports from certain foreign countries but also on account of arbitrage Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 353 transactions. For instance, if in France or Italy dollars were cheaper than another currency for which there was a demand, it was profitable to buy gold with the cheaper currency, dollars, and send it to the country whose currency was dearer in France or Italy. The trade returns for commodities and gold illustrate this. In 1920 there was an excess of commodity exports of the United States to Argentina amounting to $6 million; nevertheless there was an excess of exports of gold from the United States to Argen- tina of $88.2 million. The excess of commodity imports of the United States from Japan in 1920 was $36.7 million and the ex- cess of exports of gold was $101.3 million. Part of the excess of exports of gold from the United States may have been used to pay British and French balances in Argentina and Japan. The United States may have exported gold in settlement of accumulated' dollar balances or maturing dollar debts. As a result of the lifting of the embargo, the corrective effect of the flow of gold again became apparent, and the dollar rose on all the markets where it had been artificially depressed by reason of the inter-Allied financial unity. However, it did not rise to the same extent in those markets in which the United States had an excess of imports. iii. The Resale of American Securities One of the large factors in correcting the depreciation of the Allied exchanges was the resale of American securities which had accumulated in Europe since the Civil War. About $2000 million of American securities were returned from August, 191 4, to April, 1917- (a) Railroad Shares — Mr. L. F. Loree, President of the Delaware and Hudson Com- pany, investigated all the 144 American railroads owning more than 100 miles of line, 105 of which reported securities held abroad. From January 31, 1915, to January 31, 1917, $1,518,- 590,878 par value of American securities were returned, or 56.15 per cent of the total holdings on the earlier date, which amounted to $2,704,402,364. In the half year ending July 31, 1915, 17.78 per cent were returned, in the year ending July 31, 1916, 29.88 Digitized by Microsoft® 3 54 INTERNATIONAL FINANCE AND ITS REORGANIZATION per cent, and in the half year endmg January 31, I9l7i 8.49 P^r cent of the holdings on January 31, 1915, were returned. In other words the return flow of these securities to the United States declined slowly during the two years. It is unfortunate that Mr. Loree did not continue his in- vestigation through the period of our belligerency, when United States government advances made it unnecessary for Europe to con- tinue to sell its foreign holdings. Several isolated cases, however, indicate that after the cessation of government advances, and the release of the "peg," the sale of American securities by Europe was resumed on a small scale only. Pennsylvania Railroad common shares were held in Europe before the war to the extent of $75,- 350,000. By September 30, 1919, there were returned $64,800,000, or 87.1 per cent of the above amount. However, in the 11 months following the signing of the armistice the sales amounted to only $150,000 par value. During 1917 the reduction in the percentage of railroad stock held in Europe at the outbreak of the war aver- aged 22 per cent. Between November i, 191 6, and January i, 1 91 8, the reduction from the amount held on the earlier date w^as as follows: Pennsylvania 43 per cent, New York Central 35 per FoEEiGN Held Secitrities oi' the New York Central Ratlroad Company** Bonds and Obligations of New York Central Railroad and Leased Lines Date Amount in thousand dollars Relative figures Percentage of total outstanding August 1, 1914 February i, 1917 February i, 1919. . . . July I, 1920 121,871 31,002 32,277 23,207 100. 2S-4 26.8 18.3 18.09 4.12 4.21 304 Capital Stock of New York Central Railroad Company "By courtesy of M. S. Barger, General Treasurer of the New York Central Railroad Co. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 355 cent, Baltimore & Ohio 35 per cent, Illinois Central 24 per cent. On January i, 1918, the percentage of foreign-owned stocks re- turned since 191 5 was very large in the case of a number of roads: Pennsylvania 85 per cent, New York Central 80 per cent, Northern Pacific 70 per cent, and Illinois Central 65 per cent. ^^ The New York Central Railroad Company and leased lines kept a record of the holdings of its bonds and stocks by Europe and British possessions. The tabulation shows a heavy liquidation from the beginning of the war up to the entry of the United States. There was comparatively little liquidation during the period of the war, — in fact the European holdings of New York Central bonds increased, due to the purchase by Scandinavian neutrals. After the release of the "peg" in the early part of 1919 liquidation of the remainder continued, at a rapid rate. (b) Industrial Securities — No similar investigation with reference to the liquidation of in- dustrial securities was conducted. The report of the British Dollar Securities Committee gives no clue. Professor Bullock and associ- ates estimate that $304 million of industrial securities were re- turned up to January i, 19 17, assuming that the original figure, used by him and compiled by The Annalist is correct, and assuming that the rate of return of industrial securities was the same as that of the railroads. The figures for the United States Steel Corporation, however, show a variation in the rate of return of common stock held in Europe.** On June 30, 1914, there were 1,274,247 shares of United States Steel common held abroad. This constituted 25.07 per cent of the total amount outstanding. From July i, 191 4, to April 1, 191 7, 779,909 shares were returned or 61.3 per cent of the amount held abroad before the war. From April i, 1917, to December 31, 19 18, when United States government advances helped to stabilize sterling, only 2758 shares were returned, or 0.2 per cent of the total amount held in Europe at the outbreak of the war. From January i, 19 19, to June 30, 1920, during a large part of which period the "peg" was released, and gold flowed "Wall Street Journal, January 9, 1918. "Report of the United States Steel Corporation for the quarter ending June 30, 1920. Digitized by Microsoft® 3S6 INTERNATIONAL FINANCE AND ITS REORGANIZATION freely and exchange truly indicated international balances, the amount of common stock returned rose again. In that period of lYz years 149,013 shares were returned, or about 11.7 per cent of the total amount held abroad at the outbreak of the war. The foreign holdings of the United States Steel Corporation on June 30, 1920, amounted to 342,567 shares or 26.8 per cent of the amount held abroad at the beginning of the war. Analysis of the foreign holdings of preferred stock shows a similar though less striking record. The following table shows the great extent of the liquidation prior to the advances by the United States government in 191 7, the absence of selling during the period of these advances, and the resumption of liquidation after the "peg" was released in March, 1919. The dates respectively indicate holdings at the outbreak of the war, at the entry of the United States, at the armistice, at the release of the "peg," and ij^ years later. Foreign Holdings of United States Steel Shakes " Common Preferred Date Number of shares Relative figures Number of shares Relative figures Tune ^0, 1014. 1,274,247 494,338 491,580 493,552 323,438 100. 38.8 38.S 38.7 253 312,3" 151,757 148,225 149,832 1X8,2X2 March ^i. 1017 48.6 47.4 48.0 37.8 December 31, 1918 March ^i, loio The foreign holdings of the American Telephone & Telegraph shares show similar results. Between June 30, 1914, and March 31, 1917, about 35.8 per cent of the pre-war holdings J)f the stock was sold and 72.8 per cent of the New York Telephone Company's First and General Mortgage 4^'s. From March, 1917, to March, 1919, during the period in which sterling was stabilized, the changes were slight. European holdings of the stock increased 1.6 per cent and European holdings of the bonds decreased 2.5 per cent. Between March, 1919, and September, 1920, the selling was resumed and Europeans sold 15.7 per cent " From quarterly reports of the company. Digitized by Microsoft® PMNCttLES AND tllACtlCE IN TH£ WORLD WAS 357 of their pre-war holdings of the stock and 4.I per cent of their holdings of the bonds. Foreign Holdings of American Telephone and Telegraph Securities "^ American T. & T. Stock N. Y, Tel. Co., ist and Genl. Mtge. 4i's Date Par- amount in thousand dollars Relative figures Par- amount in thousand dollars Relative figures 13,894 8,916 9,660 9>iSo 6,9S6 100. 64.2 6S-3 65.8 50.60 36,316 9,867 8,968 8,896 7,356 100. March. ^1. I0I7 27.2 December 41410x8 24.7 March 14, 1919 March ^i. 1020 24.5 20.6 The self-corrective effect of depreciated exchange is shown in the large percentage of the European holdings of American securi- ties resold during the war. The shares of the porphyry copper companies returned between July i, 1914, and December, 1917, constituted almost 50 per cent of the foreign holdings at the earlier date. Of the shares of Utah 59 per cent were returned, of Chino 52 per cent and of Ray 30 per cent.*° During 1917, probably m the early part of the year, before the United States entered the war, 29 per cent of the foreign holdings of American Smelting common were returned.^^ iv. Sales of European Securities In addition to the liquidation of European holdings of Ameri- can securities in the New York market, the depreciated exchanges were corrected by means of sales of European securities, for which a market was created both on the New York Stock Exchange and on the curb. These securities, which were issued in foreign cur- rency, fluctuated in sympathy with the exchange rates, even though the American sub-shares and certificates were sold in dollars. 4§a gy courtesy of Walter S. Griftord, vice-president of the American Telephone and Telegraph Company. *Wall Street Journal, December 25, 1917- "Wall Street Journal, January 9, 1918, Digitized by Microsoft® 3S8 INTERNATIONAL FINANCE AND ITS REORGANIZATION (a) Industrial Stocks — The so-called international securities which were traded in on more than one stock exchange in Europe, were sold in New York. 1. Royal Dutch shares — In December, 1916, Kuhn, Loeb & Company purchased 74,000 shares of common stock of the Royal Dutch Company for the Working of Petroleum Wells in Nether- lands India. The par value is lOO guilders, which at gold parity is equivalent to $40.20. The Dutch shares were deposited with the Equitable Trust Company and against them 222,000 American certificates in dollars were issued. The block sold in this country represented about one-thirtieth of the total authorized issue, which at the date of the introduction into the New York market amounted to 2,000,000 shares. The transaction helped to stabilize sterling in New York. 2. "Shell" shares — On July 23, 1919, Kuhn, Loeb & Com- pany bought 750,000 shares of a par value of £1 of common stock of the "Shell" Transport & Trading Company, Ltd., which is affiliated with the Royal Dutch Company. This amount likewise represents about one-thirtieth of the total ordinary stock outstand- ing, amounting to 20,000,000 shares. The shares were in sterling and against them 375,000 American certificates in dollars at the rate of one American share for two British shares were issued by the Equitable Trust Company, the depositary for the British shares. In the case of both the "Shell" and the Royal Dutch shares provision was made for arbitrage transactions between the New York and London Stock Exchanges, and for the conversion back and forth of American and British shares. The "Shell" shares, placed in New York four months after the "peg" on sterling was released, helped to correct the depreciated rate of sterling at that time. 3. Rand shares — In January, 1920, 150,000 shares of ordi- nary or common stock of Rand Mines, Ltd., the leading gold-pro- ducing mines in the world, were sold in New York by a syndicate headed by Bernhard, SchoUe & Company. As in the above cases the British shares were deposited and American certificates issued against them. The basis was 3 American certificates for 5 British shares. This block also constituted a very small fraction, about 7 per cent, of the total issue, 2,125,995 shares. The par value was Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 3S9 5s. and as in the two previous cases dividends were payable at the prevailing rate of exchange. An interesting feature of the Rand securities is the fact that as commodity prices rose the dividends of this company declined. The dividend rates were as follows: 1909 — 350 per cent; 1910 to 1913 — 220 per cent; 1914 — 200 per cent; 1915 — 160 per cent; 1916 — 150 per cent; 191 7 — 145 per cent; and 191 8 — 85 per cent. The decline in commodity prices ought to result in the return of the dividends toward the pre-war level. 4. De Beers shares — ^The De Beers Consolidated Mines, Ltd., controls about 80 per cent of the output of the world's diamonds. In January, 1920, Lazard Freres of New York sold 32,000 deferred shares or common stock of this company. The par value was £2 los. The British shares were deposited with the Central Union' Trust Company and against them American shares were issued. The basis was 5 American shares for 2 of the British. This ratio was fixed merely to make the American shares of convenient denominations. In the case of De Beers also the total block sold in New York was very small, about 3 per cent of the 1,000,000 shares outstanding, and the securities likewise were traded in on the London Stock Exchange and the Paris Bourse. (b) Internal Bonds of Governments and Municipalities"^ — The depreciation of sterling in New York resulted in the sale there of sterling bonds, of many foreign states and cities in all parts of the world, the market for which had been either London alone or several of European stock exchange centers. As European exchange depreciated in New York speculation in exchange took the form of the purchase of the internal bonds of European governments and of their cities. At times the purchases amounted to $1,000,000 or more per day. The quotation list of the New York curb on December 31, 1920, included Internal 4j^'s of the French Republic, Internal 5's and 6j4's of the Russian Government, and the mark bonds of the cities of Berlin, Frank- furt, Hamburg, Magdeburg, and Vienna. The sales over the counter included a far wider range. One brokerage catalogue (Alfred R. Risse, New York) contained over one hundred kinds "a Proposals to list them on the N. Y. Stock Exchange. See the Missing Link in International Finance, by Eugene Meyer, Jr., (1921). Digitized by Microsoft® 360 INTERNATIONAL FINANCE AND ITS REORGANIZATION of foreign internal securities, for instance, two internal loans of Russia, three loans of Belgium, five of France, five of Italy, six of Great Britain, and 2i of Germany were listed. Again, 15 issues of 7 British cities and over 100 issues of 37 German cities as well as 25 issues of German industrial securities and over 25 issues of the German land mortgage banks were traded in. The decline of the exchanges stimulated the purchase of these securities in the hope that the currencies would eventually return to parity. However, the extreme depreciation of these securities points to the possibility of the devaluation of the unit of currency. Upon the further de- preciation of the exchanges, the probability of their return to gold parity diminished and the purchase of securities issued in foreign currencies was checked. Another factor undoubtedly was the threat of drastic taxation, from which the foreign holders of internal securities would not be exempted. v. Loans (a) Short-Term Bills— 1. Under normal conditions — Under normal conditions a country which is temporarily importing and consuming more than it is exporting and producing may borrow money to tide it over the interval. It may either renew its bills or else borrow from third parties. The function of a high discount rate before the war was to attract funds when a country's exchange rate depreciated. Finance bills would be raised between merchants in one country and bankers in another. These international bills were much like the domestic accommodation bills. At a time when no commercial bills are available bankers in one country will draw upon bankers in another and liquidate the debt by remitting commercial bills as soon as exports increase and make drafts available. Importers are thus able to purchase finance bills at a time when commercial bills are not available, and exporters sell bills to the same bankers at times when importers do not need drafts. Such is the normal prac- tice when there is a temporary excess of exports or of imports. 2. Treasury bills — In August, 191 7, the British govern- ment through its fiscal agents, J. P. Morgan & Company, issued treasury bills in New York for the purpose of stabilizing exchange. Between August, 1917, and November ii, 1918, the total amount outstanding reached a maximum of $84,405,000, and from the Digitized by Microsoft® PRINCIPLES AOT PKACTICP IN THE WORLD WAR 361 date of the armistice to March 20, 1919, when the "peg" was re- leased, the maximum was $91,055,000. In one week as much as $20 million was sold. The rate originally was 5 per cent, and was subsequently raised by fractions to 6 per cent. The amounts sold ranged from 7 to 8 million dollars weekly, and the period was 60 to 90 days. On July 31, 1 9 19, the French Treasury authorized a similar arrangement. J. P. Morgan & Company sold 60- and go-day French treasury bills in weekly amounts of about $5 million, and not exceeding a total of $50 million. The rate was 6 per cent originally and was raised in March, 1920, to 6^ per cent. In neither of these arrangements did the United States Treasury have any direct interest or influence. Some internal treasury bills of the European belligerents were sold in New York in 1916. In floating these bills the foreign governments had no intention of retiring them at the maturity date. They intended to refund them. For this reason the Federal Reserve Board*^ opposed the investment of the funds of the member banks in these bills. The Board felt that member banks should keep their resources liquid and not lock up their funds in obligations and investments which, though short-term in form or name, were either by contract or through force of circumstances to be renewed until normal condi- tions should return. The Board did not feel that it was in the interest of the country that the member banks should invest in foreign treasury bills. However, it disclaimed any intention of reflecting upon the financial stability of any nation. From the point of view of the borrower short-term treasury bills have a serious disadvantage. They mature continually, and cause diffi- culty in periods of credit stringency. Furthermore, as a floating debt they tend at maturity to depress the exchanges, to correct which they were originally floated. The exchange market was re- lieved when Great Britain reduced the total amount of her treasury bills in New York to $18 million in December, 1920. 3. Bank balances — ^At the outbreak of the war the United States was indebted abroad on current account to the extent of about $1000 million. The demand by Great Britain that this in- debtedness be liquidated raised sterling exchange to $7.00 on "Press statement November a8, 1916, and Federal Reserve Bulletin, December, 1916, Digitized by Microsoft® 362 INTERNATIONAL FINANCE AND ITS EEORGANXZAXION August 4, 1914. As a result of the large excess of exports the floating indebtedness of the United States was paid ofE and, further, many American banks opened credits in favor of London. Because of the existence of a free gold market in New York neutral funds were transferred to the United States. The large stock of gold in the United States made likely the redemption of the indebtedness in gold. Because of the stabilization of sterling in New York the neutrals were induced to convert their excessive sterling and franc bills into dollars, which could not be withdrawn during the period of the embargo. When the embargo was lifted and the sterling "peg" released, the exchange of the European neutrals declined in New York and they could not therefore withdraw gold. Their bank balances in New York then were used to correct their de- clining exchanges. (b) Long-Term Loans — I. Floated before the armistice — ^An important correc- tive of the depreciated exchanges in New York was the long-term credit extended to the Allied Powers. The loans to Great Britain and France have been treated in detail in the section on public finance. Germany received no credit in New York with the ex- ception of one small short-term loan for $15 million underwritten by Chandler & Company. The total loans issued in the United States up to December 31, 1918, according to Prof. Bullock and associates, amounted to $1751 million and the amount outstanding on January I, 1919, was $1689 million.*^ Probably because he included unannounced issues, held by banks and bankers, Mr. Thomas W. Lamont, of J. P. Morgan & Com- pany, presented much larger totals. According to the records of his firm on January i, 191 9, there were held by American in- vestors and bankers $2200 million of foreign government obliga- tions issued after the war began. In addition to the foregoing government issues in the hands of American bankers and investors, Mr. Lamont estimated that there were held $500 million of foreign private obligations.'"'* "Balance of Trade of the United States, ibid. "" Journal of Commerce, January a, 1919. Annual Report of the Secretary of the Treasury for igao. Exhibit 33, pp. 351-4, Estimate of Financial Obligations of Foreign Governments oflfered in the United States from August i, 1914, to December 31, 1919, gives a total of $4,129.8 million including $950 million of Canadian In- ternal Loans, of which part was taken in the United States. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 363 Loans (Other than Cbedits Established by the Government) Placed IN THE United States from Aug. i, 1914, to Dec. 31, 1918, and Amounts Outstanding on Dec. 31, 1918, According to Prof. Bullock (in million dollais) Class Orignal amount issued in United States Amount outstanding in United States on Dec. 31, 1918 I. Govenupent loans: 700 4SO 1 75 85 30 ID S S s s 35 652 45° I7S 8S 30 France Canada Argentina Germany 2 Newfoundland 5 Norway e 5 China e 2.9 Total 1473-5 104.6 86 6 1416.9 2. Mimicipal and provincial: Canada 103.8 France 86 Brazil and Chile S-9 Total 196.6 27.1 ISO 195.7 3. Railroad loans: 23.4 Argentina 15.0 Total 42.1 II. 2 26.2 1-3 38.4 4. Industrial loans: Canada 10.7 S. Public utility loans: Canada 26.2 Australia 1-3 Total 27-5 I7SO-9 27. S Gi3.nd total 1689.2 Of the loans issued at any previous time in the United States those outstanding on January i, 191 9, amounted to about $2200 million, not including subscriptions to foreign internal loans except Digitized by Microsoft® 364 INTERNATIONAL FINANCE AND ITS REORGANIZATION the French Government Internal 5's due in 1931 and the Russian Government Sj^'s due in 1926. Foreign Government Obligations Issued and Outstanding Heib by Private Interests on Jan. i, 1919, According to Mr. Lamont (in million dollars) Country- Great Britain France Russia Italy Germany Switzerland Greece Sweden Norway China Canada Argentina ChUe Bolivia Panama Uruguay Yucatan Brazil Miscellaneous Total Foreign Loans in the United States Outstanding Jan. 1, 1910 " (in million dollars) Country Amount Country Amount 723 -4 S3S-S 462.7 128.6 ro7.8 85.0 47-7 12.9 10. Brazil SS S-o 45 a. 9 2 France. Norway land Bolivia Taoan Germany ... Peru Argentina Australia ... I 2 Santo Domingo Cuba Chile O.d. Denmark 2 Total 2163.8 " Statement of the Guaranty Trust Co, Also reprinted in the Federal Reserve Bulletin, January, 1919. Digitized by Microsoft® PRINCIPLES AND PRACTICi; IN THE WORtD WAR 365 This amount does not include cash advances and other charges against credits established by the United States, but does include loans placed in the American investment market at any time by foreign governments, states and municipalities, and private corpora- tions, railroads, public utilities and industrial corporations. A similar table as of July i, 1920, gives a total of $2332 million.^* 2. Loans floated after the armisticb — ^After the signing of the armistice the belligerents of Europe floated huge loans in the New York market. After the release of the "peg" in March, 1919, when the exchange rates of the countries of Europe declined below parity in the New York market, the neutrals too called upon the American investor for funds. On December 31, 1920, there were listed on the New York Stock Exchange the bonds of the United Kingdom, the French Government, the Kingdom of Italy, Kingdom of Belgium, the Government of Switzerland and five issues of the Dominion of Canada. In addition the securities of several European cities were Hsted^the bonds of Paris, Bordeaux, Lyons, and Marseilles, of Berne, Zurich, Copenhagen, Christiania, and Tokio. The bonds of the kingdoms of Denmark and Norway were listed on the curb and subsequently transferred to the Stock Exchange. The total loans floated in the United States between the date of the armistice and January i, 1921, were $783.3 million. Several of the loans included in this amount were renewals of loans previously placed.^* 3. Investment trusts — ^The proposal for an investment trust was put forth a month after the armistice was signed." The idea was well received in commercial and financial circles, and subsequently many tentative proposals were made. (a) European investment trusts — ^The investment trust is an established financial institution in Europe. The rate of interest on °' Also reprinted in Federal Reserve Bulletin, July, 1920. "Journal of Commerce, January 3, 1921. This paper printed the totals as well as the individual issues on the first day of the month during 1920 and part of 1919. "* Address of Paul M. Warburg at the Emergency and Reconstruction Congress of the War Service Committees of American Industries, De- cember, 1918, at Atlantic City. Subsequently printed in the Annals of the Academy of Pglitical ai)d Social Science and in The Nation's Business during 1919. Digitized by Microsoft® 366 INTERNATIONAL FINANCE AND ITS REORGANIZATIOU the bonds of the home governments was less than the rate on foreign obligations. The accumulation of savings in Europe sought profit- able investments and as a result investment trusts were developed. These trusts originated in Scotland in i860, and grew in number thereafter. The underlying principle is the diversification of risk, which is made possible by pooling many small funds of savings. Under the guardianship of experienced financiers these are invested in ventures abroad. The British Investment Trust, Ltd., the Metropolitan Trust, Ltd., the Second Edinburgh Investment Trust, Ltd., and the Investment Trust Corporation, Ltd., owned from 200 to 315 separate issues, including bonds of foreign governments, municipalities and the securities of railroads, public utilities and banking, manufacturing and trading corporations. The diversifica- tion of investments affords stability. The British investment trusts have specialized in particular enterprises such as rubber and tea plantations or mining. These institutions built up British interests abroad and aided in the development of foreign countries, such as the United States, Argentina, Canada and Australia. The con- tinental trusts specialize in their investments. Typical of this specialization are the Trust for Electrical Enterprises in Berlin, the Trust for Rubber Securities in Antwerp, and the Trust for Metal Securities in Basle. These trusts buy both stable investment securities and speculative securities. Again, at times they buy for the purpose of securing control. Before the war the yield was fairly high, 8 or 10 per cent, and the expense of operation was from 0.2 to 0.5 per cent of the investment. A list of the European trusts may be found in the year books of the various stock ex- changes, such as the Stock Exchange Year Book of London, Saal- ing's Boersenhandbuch of Berlin, Van Oss' Effectenhandboek of Amsterdam, the Annuaire Desfosses of Paris, and the Recueil Financier of Brussels. ^^ (b) American investment trusts — ^Among the financial institu- tions of the United States the analogue of the investment trust is ,the holding company. Many of the public utility corporations in reality are investment trusts specializing in public utilities. The American International Corporation, formed in 1916, is /somewhat similar to the investment trusts of Europ?. According to its official statement the business transacted by it includes par- " For further discussion see Federal Reserve Bulletin, November, 1920, for article by T. H. Thiesing of the Inter-American High Commission. Digitized by Microsoft® PRINCrPLES AND PRACTICE IN THE WORLD WAR 367 ticipation in foreign corporations or in domestic corporations doing a foreign business. Such participation is achieved through the in- vestment in corporate securities. Some securities are held for in- come, others are sold from time to time. The American Inter- national Corporation operates much like a holding company, which buys part or all of the securities of another company for purposes of control. Another American institution similar to the investment trust is the Foreign Bond and Share Corporation, which was formed in May, 1919. Its purpose, as stated in its prospectus, is to finance public and private enterprises in Central and South America, the Far East, Europe, and other parts of the world and to sell the debentures of the corporation based upon them. Its directorate consists of representatives of prominent financial institutions, in several parts of the country. 4. The War Finance Corporation — ^The investment trusts in the United States and the Edge law corporations, to be dis- cussed below, were not formed for the purpose of correcting foreign exchange rates. Their prime purpose, to mobilize the investment funds of the United States and to extend credit to foreign countries, would have the effect of correcting exchange rates. For borrowing by a country creates credits in its favor just as exports would, and lending by a country creates debits just as imports would. The need for materials by the countries of Europe, whose currencies were depreciated, was met temporarily and in small part by the War Finance Corporation. This institution was organized in the Treasury Department with a capital of $500 million, all owned and paid for by the United States Treasury. Its power to aid exports was granted under the Victory Note Act passed on March 3, 1919. It was not very active because during the period of its functioning, the United States government itself made advances to the countries of Europe partly out of the original $10,000 million fund, gave credits authorized by the Victory Note Act for the sale of surplus army supplies left in Europe, extended credits for the sale of wheat, the price of which was guaranteed, and advanced monies for relief. As these credits expired, applications for loans were received by the War Finance CofpioratiOn. Up to May 10, 1920, when, under orders from Digitized by Microsoft® 368 INTERNATIONAL FINANCE AND ITS REORGANIZATION the Secretary of the Treasury, it ceased making loans, the com- mitments entered into amounted to about $50 million, of which about $30 million was advanced in cash. About $100 million^ of applications were pending at the time of the suspension of activity. In theory the War Finance Corporation operated like the European investment trusts. It took the obligations of the American exporter backed by the paper of the European importer, endorsed by his bank and guaranteed by his government. On the other hand the corporation expected to obtain additional funds through the sale of its own debentures, the first series of which amounting to $200 million, were issued in 191 9 (though not under the amend- ment authorizing the promotion of exports), 5, Edge law corporations— The War Finance Corporation was considered as an expedient for the transition period only. The law provided for the cessation of its activity one year after the proclamation of peace. However, the function of the War Finance Corporation was to be exercised in the post-war period by private initiative, under S.2742, the so-called Edge Law, which authorized banking corporations to do a foreign banking business. a. The law — 'The Edge Law, approved December 24, 1919, is an amendment to the Federal Reserve Act. It authorized cor- porations to be organized for the purpose of engaging in inter- national financial operations, either directly in a dependency or insular possession of the United States or through the agency of control of local institutions in foreign countries. Such corporations are put under the control of the Federal Reserve Board. In addition to a wide variety of banking powers such as the power to purchase, sell, discount and negotiate with or without endorse- ment, notes, drafts, checks, bills of exchange, acceptances and evidences of indebtedness, and to purchase and sell securities, Edge-law corporations may issue debentures, bonds and promissory notes, but not exceeding 10 times their capital stock and surplus. Furthermore, such corporations have the power, with the consent of the Federal Reserve Board, to purchase and hold stock or other certificates of ownership in any other corporation not transacting any business in the United States, except such as may be incidental to its international foreign business, b. Companies formed — ^The First Federal Foreign Banking Corporation, of New York, was organized under the Edge Law, Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 369 shortly after its passage. The sharp decline in the exchanges in 1919 and in 1920 delayed the formation of other similar corpora- tions. Furthermore the suspension of the War Finance Corpora- tion in the spring of 1920 caused the abandonment of plans for the organization of similar additional companies, for these expected to obtain loans from the War Finance Corporation if conditions in the investment market should make it difficult for them to obtain funds from the public. The sharp decline in prices toward the end of 1920 created a strong demand throughout the country that the bankers give some relief. In response to this pressure the American Bankers' Association projected the Foreign Trade Financing Cor- poration with a capital of $100 million. The cotton planters, who were very severely afifected by the decline in prices, likewise organized on December 29, 1920, the Federal International Bank- ing Corporation with a capital of $7 million. The former com- pany never was organized. The latter was not called to active, functioning ov/ing to the sharp rise in cotton prices in the fall of 1921. The deranged condition of the exchanges prevented further large exports from the United States. The damming back of the flow of goods accelerated the world-wide drop in prices. The immediate purpose of financial institutions along the lines of the European Investment trust or the Edge Law corporations was to advance credit to Europe, to correct the declining exchanges, and to sustain the normal currents of trade. vi. The Control of the Movement of Capital (a) Control of the Movement of Capital in the United States — During the war legislation was enacted whose prime purpose was to check the financial operations of enemy aliens. Subdivision b, section V, of the "Trading with the Enemy Act" as amended gave the President power to investigate, regulate, and prohibit by means of licenses or otherwise any transactions in foreign exchange and the exportation, hoarding, melting or earmarking of gold, silver, coin, or bullion or currency, transfers of credit of any form (other than credits relating to transactions wholly within the United States) , and transfers of evidences of indebtedness or of the owner- ship of property between the United States and any foreign countries, whether enemy or ally of enemy, or between residents Digitized by Microsoft® 370 INTERNATIONAL FINANCE AND ITS KEOECANIZATION of one or more foreign countries by any person within the United States. To give effect to this legislation the Division of Foreign Exchange of the Federal Reserve Board classified dealers in foreign securities into three groups. Those in Class C w^ere dealers who carried accounts or securities or who dealt in securities for foreign correspondents, but who did not carry accounts or securities with foreign correspondents, or deal through foreign correspondents. In other words Class C consisted of dealers who operated in the United States. Class B were dealers who carried accounts or securities with foreign correspondents or who dealt through such correspondents, but did not carry accounts or deal in securities for foreign correspondents. In other words, Class B were dealers in the United States who operated abroad. Class A consisted of dealers who dealt in securities for foreign correspondents or through foreign correspondents, and who carried accounts or securities with or for them. In other words. Class A consisted of dealers who operated in the United States for foreign account and who operated abroad through correspondents. Dealers were licensed and the Division of Foreign Exchange of the Federal Reserve Board always retained the right to restrict the operations of any licensee, with the object of preventing Germany from realizing on property or credit in neutral countries for the purpose of establishing credit or for the purchase of war materials.''" (b) Control of the Movement of Capital by Foreign Countries — Other countries liicewise regulated operations in foreign exchange, not only for the purpose of preventing the enemy from realizing on property held abroad, but also for the purpose of stabilizing exchange. Most of the belligerents forbade the expor- tation of currency or securities, the countries including Great Britain, France, Belgium, Roumania, Greece, Portugal, and Brazil. A good many countries prohibited speculation in exchange and restricted purchases and sales of foreign drafts to bona fide trade operations. Among such countries were Italy, Belgium, Greece, Czecho-Slovakia and Jugoslavia. Czecho-Slovakia went so far as to require the payments for its exports to be made in foreign "Executive Order of the President, dated Jan. aS, 1918, and Instruc- tions to Dealers, issued by the Federal Reserve Board, Division of Foreign Exchange. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 371 currency. The licensing and control of dealers operating in foreign exchange was practised by Germany, Italy, Belgium, Roumania, Greece, Portugal and Czecho-Slovakia. Several countries cen- tralized all dealings in foreign exchange in order to secure better control, among them being Germany, Austria, Bulgaria, France, Italy, Roumania, Greece, Czecho-Slovakia, Jugoslavia, Finland, and Spain. F. Stabilization of the Allied Exchanges in New York i. Mechanism of the "Peg" The United States government was not ofEcially concerned in the mechanism of the stabilization of the Allied exchanges in New York. Government advances to the Allies were made for the purpose of supplying them with war materials. Of course these advances helped Great Britain in continuing to "peg" the exchanges. The "pegging" operation was undertaken by Great Britain as soon as sterling began to depreciate, and it was con- tinued until April, 1919. The United States government advances began on April 24, 1917, and continued until March 10, 1920. (a) United States Government Advances to the Allies — 1. The law^' — By the Acts of Congress of April 24, 1917, and September 24, 191 7, known as the First and Second Liberty Bond Acts, and by the amendments thereto, the Secretary of the Treasury, with the approval of the President, was authorized to establish credits in favor of the Allies, and to the extent of the credits to purchase at par from the Allies their several obligations. The Secretary was guiaed by the necessities of the Allies for sup- plies and materials. According to the law the authority granted to the Secretary to establish credits to foreign governments was to cease upon the termination of the war, but the Secretary fixed March 10, 1920, as the date of cessation. " Sections a and 3 of the Second Liberty Bond Act. Digitized by Microsoft® 372 INTERNATIONAL FINANCE AND ITS REOSGANIZATION a. The amounts — ^The total amount authorized was $10,000 million, as follows:"* Million dollais First Liberty Bond Act, April 24, 1917 3,°°° Second Liberty Bond Act, Sept. 24, 1917 4,ooo Third Liberty Bond Act, April 4,1918 1,5°° Fourth Liberty Bond Act, July 9,1918 1,5°° Total 10,000 On March 10, 1920, the Secretary discontinued the establish- ing of any new credits in favor of the Allies and limited the cash advances under established credits to the actual needs in connec- tion with contracts for war materials. From April 24, 1917, up to November 15, 1920, the credits established, after deducting credits which had been withdrawn, amounted to $9711 million, distributed as follows: Countries Net credits established in million dollars Great Britain 4277 3048 1666 Italy 349 188 Russia 68 Greece 48 26 Roumania 25 Cuba . Liberia . S Total, 9711 The amounts established corresponded roughly with the amounts of exports from the United States to the several countries. In the case of France and Italy the advances from the United States Treasury at one time exceeded the amounts of exports. From April 24, 1917, to June 30, 1919, the total cash advances to the Allies amounted to $9092 million, and the total exports "See the several Liberty Bond Acts, also Report of the Secretary of the Treasury, 1920, p. 53. Digitized by Microsoft® PRINCIPLES And practice in the world war 373 from the United States to the countries involved amounted to $8624 million. Country Advances from United States treasury (in million dollars) Exports from the United States (in million dollars) United Kingdom France Italy Belgium Russia All others Total 9092 8624 3. The form of the debt — In settlement of these advances the Allied governments gave their obligations, vi^hich were short- term or demand certificates of indebtedness signed by duly author- ized representatives of the several governments receiving the advances. These obligations were to be converted at par with an adjustment for accrued interest into an equal par amount of gold bonds of the governments concerned. 4. The rate of interest — ^The law originally placed the interest on the foreign obligations at 3 per cent per annum and increased it thereafter to 3j4 per cent, to 3j^ per cent, to 4j4 per cent, and finally to 5 per cent to conform to the rising cost of funds to the United States government. Above a minimum the rate of interest chargeable to the foreign governments was not fixed under the terms of the act but was left to the discretion of the Secretary. Accordingly the Secretary charged the foreign governments J^ per cent more than the rate paid by the United States government to compensate in part for the loss to the United States arising from the issue of tax-exempt bonds and for the cost of floating. The rate of interest borne by any obligation in pay- ment of advances made by the United States government was not to be less than the highest rate borne by any bonds of the United States. The rate of interest of the long-term bonds into which the short-term obligations of the foreign governments might be converted was to be not less than the rate of the short-term obliga- tions. The Interest due up to May 15, 191 9, except in the case Digitized by Microsoft® 374 INTERNATIONAL FINANCE AND ITS REORGANIZATION of Russia, was paid in cash. To the extent that such interest was not paid from other resources of the governments concerned, it was paid from the proceeds of further loans made by the United States. The interest accrued and unpaid for the three semi- annual periods ending October 15, 1920, and November 15, 1920, amounted to $693 million, distributed as follows: Interest Accrued and Unpaid " (in million dollars) Country Amount Great Britain France Italy Belgium Russia Czecho-Slovakia . Servia Roumania Total 314.6 211-5 120.2 2S-3 14.1 4.0 2.0 1.6 693 -3 5. Maturity of the principal — ^The maturity of the obliga- tions of the foreign governments was fixed under Section 8 of the Victory Note Act. The obligations of foreign governments acquired by the Secretary of the Treasury were to mature at such dates as might be determined by the Secretary provided that such obligations acquired under the provisions of the First Liberty Bond Act or upon the conversion of short-time obligations acquired thereunder were to mature not later than June 15, 1947, and all other such obligations of foreign governments were to mature not later than October 15, 1938. The early certificates or obliga- tions of the foreign governments were payable at fixed dates of maturity, all of which had passed, so that they were regarded as demand obligations. However, the Secretary was authorized to receive payments on or before maturity, of any obligations of foreign governments acquired by the United States and to sell any such obligations at not less than purchase price plus accrued interest, and to apply the proceeds to the redemption or purchase of any bonds of the " Report of the Secretary of the Treasury, 1920, pp. 57-58. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 375 United States. Up to November 15, 1926, about $115 million was repaid, distributed as follows i'" Million dollars Great Britain 80. 2 France 31 .4 Roumania 1.8 Servia 0.6 Cuba 0.5 Total 114. S (b) The Expenditures 0/ the United States Army Abroad — The purchases of European supplies by the United States for the army abroad helped indirectly in stabilizing the Allied exchanges. The currencies needed by the United States in France, Great Britain, and Italy for war expenditures in those countries were provided by the foreign governments. Under Section 4 of the Second Liberty Bond Act as amended, the Secretary of the Treasury was authorized to make arrangements during the war and for two years after its termination in or with foreign governments to stabilize the foreign exchanges and to obtain foreign currencies and credits in such countries. He was empowered to use any such credits or currencies for the purpose of stabilizing or rectify- ing the foreign exchanges. Equivalent amounts of dollars were made available to these foreign governments to meet their war expenditures in the United States. The total expenditures from January, 1918, up to November, 1920, when the account was practically closed, amounted to $1491 million, distributed as follows : DoixAK Equtvalents Paid by the United States for Foreign Currencies Million dollars Belgium 1.2 France 1025.4 Great Britain 449-S Italy 144 Total 1490.S By this arrangement the needs of the foreign governments for advances from the United States were reduced.*^ " Report of the Secretary of the Treasury, 1930, p. 53. "Reports of the Secretary of the Treasury for 1918, p. 36; 1919, pp. 66-67; 19201 P- 67. Digitized by Microsoft® 376 INTERNATIONAL FINANCE AND ITS REORGANIZATION (c) Credits for the Purchase of Army Property and of Guaranteed Wheat — Additional credits were authorized under the Victory Note Act (Section 7) whereby until 18 months after the termination of the war the Secretary of the Treasury was empowered to establish credits for any of the Allied governments for the pur- pose of providing for the purchase of property owned but not needed by the United States and of any wheat the price of which had been guaranteed by the United States. The foreign government was to give in payment its obligation bearing interest at the rate of 5 per cent per annum and maturing not later than October I5> 1938. The foreign obligations received through the Secretary of War up to November 15, 1920, on account of the sales of surplus war supplies aggregated $563 million, distributed as follows : Million dollars France 400.0 Poland 57.6 Belgitim 27.6 Jugoslavia 25 . o Czecho-Slovakia 20. 6 Roumania 12.9 Esthonia 12.2 Lithuania 4.2 Latvia 2.5 Russia 0.4 Total. S63-0 Foreign obligations received through the American Relief Administration on account of relief rendered under the Act approved February 25, 1919, and held by the Treasury as cus- todian amounted to $84 million, distributed as follows ; Million dollars Poland 51.7 Finland 8.3 Roumania 8.0 Czecho-Slovakia 6.3 Russia 4,5 Latvia 2.6 Esthonia 1.8 Lithuania 0.8 Total 84.0 Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 377 (d) Brituh Treasury Bills — The actual stabilization of exchange was accomplished through the purchase and sale of British treasury bills in the open market in New York. The details concerning British and French treasury bills have been given above. The amount of sterling exchange purchased for the account of Great Britain by J. P. Morgan & Company, her fiscal agents, in the period from the spring of 1915 until the spring of 19 1 9 was almost £840 million. The Bank of France bought f r. 1 8,000 million of French exchange. This sum was provided partly from the resources of the Bank and partly from credits opened in London and New^ York in favor of the Bank and of the French Treasury. (e) Licensing of Dealers in Exchange — The licensing of dealers in foreign exchange during the bel- ligerency of the United States made it possible to centralize and control the foreign exchange operations of all dealers in the United States. The total amount bought and sold was recorded and the reason for any particular transaction was a proper subject for inquiry and restriction by the Division of Foreign Exchange of the Federal Reserve Board. The control of exports and imports by the War Trade Board, the embargo on gold and the control of the foreign exchange operations by the Federal Reserve Board, all facilitated the "pegging" of the Allied exchanges in New York. ii. The Effects of the "Peg" The stabilization of the Allied exchanges interfered with the self-corrective effects of changes in the visible and invisible trade balance. The anomalous effects were noticeable not only on the stabilized currencies, sterling, francs and lire, but on the dollar and also on the neutral currencies. The stabilization of sterling in New York distorted exchange rates throughout the world. (a) The Effect on the Allied Powers — I. The MAINTENANCE OF AN ARTIFICIAL LEVEL In SpIte of a huge excess of imports the Allied exchanges remained fairly close to par. The excess of imports increased in unparalleled Digitized by Microsoft® 378 INTERNATIONAL FINANCE AND ITS EEORGANIZATION fashion; in the case of the United Kingdom, from the equivalent of about $1157 million in 1913 to about $2917 million in 1917; in the case of France, from the equivalent of about $3cxj million in 1913 to $3000 million in 191 7; and in the case of Italy, from about $219 million in 1919 to about $2000 million in 1917.'^ And yet during the period of the "peg" sterling fluctuated in the New York market about 2 per cent below? par and francs from 5 to 12 per cent. In furtherance of the common military aim, it was necessary to preserve the credit of the Allied governments and to maintain their purchasing power in foreign markets. The support of the Allied exchanges tied them to the dollar. The fluctuations in the Allied exchanges resulted not from the factors both visible and invisible that determined the balance of trade of the individual countries but from the total Allied exports, imports, ocean freights, interest charges and other factors in the combined trade balance of all the Allies. 2. The failure of the self-correctives — ^The maintenance of the Allied rates at an artificially high level prevented their self- correction. Because the rates did not fall to their natural level the imports of the Allies were not checked nor were the exports stimulated. The Allied powers gave us fewer pounds sterling, francs or lire for American exports than they would have if the exchanges had fallen to their natural level. Likewise the Allies received more dollars for their exports to the United States. Of course commercial considerations were set at naught, because mili- tary considerations were primary. 3. Financial weakness concealed — ^The healthy effect of depreciation in reducing imports and in stimulating exports was not felt during the period of stabilization. But the prolongation of support by the strong countries concealed the unsoundness of the stabilized currencies. Therefore when the expedients for stabiliza- tion were abandoned, the shock was severe in both France and Italy. Had the "peg" been further continued the disarrangement would have been more painful. The stabilization of the exchanges created a fool's paradise for some of the nations of Europe. The release of the exchanges was an admonition to adjust themselves to realities. " See the writer's International Commerce and Reconstruction, p. 6». Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 379 4. Strengthening of British prestige^' — ^The records of the Division of Foreign Exchange of the Federal Reserve Board show the focal position of Great Britain in the international finan- cial system. From February 20, 1918, to June 25, 1919, the period in which the foreign exchanges were under control in the United States, the total exchanges from all sources on all countries of the world purchased by American dealers was $11,770 million, while the total amount sold was $11,747 million. About 55 per cent represented dealings in sterling. a. Sales of sterling between United States dealers — Of the $9980 million total purchases and sales of exchange between dealers in the United States during this period approximately 69 per cent was for exchange on Great Britain. During the period from February 20, 1918 to December 31, 1918, the corresponding figure was 72 per cent. b. Sales of sterling by foreign holders — Sterling bills were sold in the United States by foreign holders from February 20, 1918, to June 25, 1919, to the extent of $928 million. Purchase of sterling by foreigners from American dealers amounted to $905 million. An excess of sterling bills of $23 million was offered on the New York market. The British banks operated as inter- mediaries for foreign accounts. Purchases by American dealers of sterling exchange from the neutral countries were greatly in excess of the sales of sterling exchange to them. For instance, during nine months of 191 8 Spain sold to the United States $12,143,000 of sterling exchange and purchased $8,531,000 in sterling, a balance in Spain's favor of $3,612,000. The excess explains not only the slight depreciation of the Allied exchanges in New York but the heavy depreciation of the dollar and the currencies of the Allies on the neutral markets. During the period of the gold embargo, which coincided largely with the period of control of the exchanges, sales of sterling in the United States covered current trade rather than accumulated balances. But prior to the enforcement of the embargo, sterling exchange was sold in New York for foreign account to a much larger extent. c. British operations in neutral currencies — ^The important position of Great Britain in foreign exchange is borne out by the "Annual Report of the Federal Reserve Board, 1918, p. 53, and 1919. P- 47- Digitized by Microsoft® 380 INTERNATIONAL FINANCE AND ITS REORGANIZATION large transactions in neutral currencies which were cleared through Great Britain en route to and from the United States. The United States bought $34,622,000 of neutral currencies from Great Britain but sold only $9,322,000 to Great Britain, leaving an excess of purchases of neutral currencies from Great Britain by the United States of $25,300,000 for the period February 20, 191 8 to Decem- ber 31, 1918. Transactions in Neutral CuREENcrES Between Great Britain and the United States (in thousand dollars) Currency- Purchases by United States from Great Britain Sales by United States to Great Britain Excess of Purchases by United States Dutch guilders Norwegian kroner. . . Swedish kroner Spanish pesetas Swiss francs 6,721 4,392 5,379 13,324 4,806 2947 1738 1349 914 2374 3.774 2,654 4,030 12,410 2,432 Total 34,622 9322 25,300 The arbitrage transactions of American dealers during the entire period of control of exchange (February 20, 1918, to June 25, 1919) amounted to almost $3,000 million, most of which were handled through Great Britain. Purchases from other countries through arbitrage by United States dealers $1,606,710,000 Sales to other countries through arbitrage by United States dealers 1,296,454,000 Excess of purchases by United States dealers through arbitrage 310,256,000 This huge excess of purchases of arbitraged exchange explains both the depreciation of the dollar and of the Allied currencies on the neutral markets as well as the stabilization of the Allied ex- changes in New York. (b) Effect on Neutrals — The one remarkable and outstanding effect of the stabil- ization of sterling in New York was the decline on the neutral markets of the exchanges of the Allied and Associated powers. Digitized by Microsoft® PRINCIPLES AND PEACTICE IN THE WORLD WAR 381 I. Trade currents — In the trade with the European neutrals the United States had an excess of exports, as shown above, and therefore if the dollar had not been tied to the Allied currencies, it should have been at a premium on the neutral markets. On the other hand in the trade with the South American countries the United States had an excess of imports, particularly so toward the end of the war. In these countries therefore the dollar should have been at a slight discount. The significant thing, however, is that the trade of several neutral countries with the rest of the world showed a greater increase of exports than of imports during the war. The following had an excess of exports over imports: Spain, Sweden, Argentina, Brazil, and Chile. The other neutrals, Norway, Denmark, Holland and Switzerland, had an excess of imports, which how- ever was much smaller than the pre-war figure. Excess or Exports BEroRE and Dotung the War " (— ) excess of imports; (+) excess of exports (in millions) Comitry Sweden Spain .Aj^gentina Brazil Chile 1913 1917 — 29 kroner — 248 pesetas + 23 pesos — 3S milreis + 67 pesos +418 kroner (1916) +577 pesetas +169 pesos +299 milreis +357 pesos Excess of Imports Before and During the War (in millions) Country 1913 1917 Denmark — 137 kroner —83s gmlders -543 francs — 49 kroner — 286 guilders — 82 francs Netherlands Switzerland On the other hand, corresponding to an increase in the balance of exports or to the decrease in the balance of imports of the neutrals, the imports of the several Allied powers greatly increased, as cited abqve. As a result, the Allied exchanges, tied together, and taken as a whole, depreciated in the neutral markets. For instance, during the calender year 191 7 Spain had an excess of "International Commerce and Reconstructioji, pp. 317, et seg. Digitized by Microsoft® 383 INTEKNATIONAt TINANCE AND ITS REORGANIZATION exports to England of about $82 million and of over $300 million in her trade with the three principal European belligerents. The British excess of imports from Spain rose from the equiva- lent of about $28 million in 1913 to $130 million in 1918. The French excess of imports from Spain rose from the equivalent of about $25 million in 1913 to about $222 million in 191 7. The combined value of the British and French excess of imports from Spain rose from the equivalent of $53 million in 191 3 to the equivalent of $303 million in 1917. On the other hand the excess of exports from the United States to Spain rose from about $8 million in 19 13 to about $43 million in 19 18. The establishment of a stabilized pound and franc in New York tied the three coun- tries into a trading unit, so far as their foreign exchanges were concerned. Great Britain, France and the United States, combined, had a net excess of imports from Spain equivalent to $45 million in 1913, $263 million in 1917, and $165 million in 1918. Spain's Balance of Trade with Leading Ailies " (in million dollars) (conversion at parity) 1913 igi6 I9I7 1918 British excess of imports from Spain French excess of imports from Spain 28.0 2S-2 72.3 134.0 80.7 222.0 130 s 78.0 Combined British and French excess S3- 2 206.3 302.7 208. s United States excess exports to Spain 8.2 2S.O 40.1 42.6 Combined net excess of imports from Spain of United States, Great Britam and France .... 4SO 181.3 262.6 165.9 2. Difficulties in Allied settlements for trade bal- ances — ^The principal means of settling for a debit balance is the shipment of goods. The Allies were unable to ship goods during the war to the neutral countries in payment of their purchases of military supplies. In many cases the Allies intentionally withheld settlement by exports for fear that the commodities shipped would ultimately reach Germany. The second factor in settlement of trade balances, likewise, was not available. Gold was sent to New York, the main market "From official annual returns of trade. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 383 for Allied purchases of military supplies. The object was not only to pay for purchases, but also to maintain easy credit conditions and to facilitate loans. The Allies had not unlimited gold supplies and thus could not settle for all their excess of imports by means of gold. Furthermore, several of the neutrals refused gold in payment of merchandise debts. The Scandinavian countries, in which there was a great scarcity of goods, at first put an embargo on the importation of gold and later accepted it only at a discount of 8 per cent, because the increased quantity of gold coupled with the scarcity of commodities caused an unsettling rise in prices. Similarly Spain received gold at a discount of 6 per cent below its parity. These countries preferred to have settlement in merchan- dise rather than in specie. Finally, the third means of settlement, securities, was not available. The neutral countries did not lend to the Allies to settle for their excess of imports, partly out of fear of Germany and partly because of the war-time restrictions on the issue and move- ment of securities. 3. Arbitrage in Allied exchanges — ^The dollar depreciated as a result of the arbitrage operations in the Allied exchanges. Before the war arbitrage eliminated differences in the quotation of any currency on two or more markets. Speculators transferred their credits from one financial center to another and would buy a currency in the cheap market and sell it in the dear market. These operations stabilized exchange before the war. The margin of profit was very close and the fluctuations in exchange were kept within very narrow bounds. a. Mode of operation — During the war the differences were much wider and the profit correspondingly greater. Foreign ex- change operators bought sterling, francs and lire in the neutral free markets and sold them in the "pegged" New York market. An importer of Madrid who bought goods in England and agreed to pay for them in London might remit directly by purchasing depreciated sterling in Madrid or else he might buy dollars in Madrid and sell these dollars in New York and buy sterling which he would forward to London in settlement of his purchase. The sales of dollars in New York depressed the dollar in terms of pesetas. Similarly a Spanish merchant who exported to England and was paid in sterling might sell depreciated sterling in Madrid or else sell sterling in New York, where it was "pegged," and Digitized by Microsoft® 384 INTERNATIONAL FINANCE AND ITS REORGANIZATION obtain dollars and sell dollars in Madrid. The fact that the ex- porter had the choice of operating either directly between London and Madrid or indirectly via New York made the dollar fall and the pound sterling rise. b. The defeat of the aim of stabilization — ^As a result of arbi- traging the dollar and the pound the neutrals were able to defeat the aim of the "peg," which was to maintain an artificial purchas- ing power for the Allied currencies. The neutrals who operated for a profit were accused by the Allied powers of unfriendly acts. However, close supervision by the Foreign Exchange Division of the Federal Reserve Board prevented the enemy powers from obtaining credits or depressing dollars by the sale of American or Allied securities through the agency of neutrals. The defeat of the aim of the "peg" was not the result of enemy activities, but purely the result of the operation of economic laws. The neutrals bought sterling in a market where it was in excess and sold it in a market in which an artificial demand was created for it. c. The effect of arbitrage — ^The extent of the resulting depre- ciation of the dollar abroad, or of the premium of the neutral currencies in New York, was striking. In November, 1917, Swedish kroner were at a premium of about 70 per cent in New York and in April, 1918, Spanish pesetas were at a premium of about 54 per cent. Premiums on Neutral Currencies in New York " During the Period OF THE "Peg" Currency of — Highest Premium between April, 191 7, and July 31, 1918 Highest Premium, July, 1918 When reached Per cent Percent Sweden Nov., 1917 Nov., 1917 Nov., 1917 July, 1918 May, 1918 April, 1918 Sept., 1917 Juy, 1918 June, 1918 July, 1918 Dec, 1917 69.78 44-59 44- S9 29.3s 3S-28 54- IS 22,30 7.82 78.24 20,83 10. 2S 33-58 17.91 16.79 29.3s 31 SO 42.7s 10.14 Norway Denmark Holland India Japan 7.8a Argentina 7S-48 20.83 8.84 Peru Bolivia : z " Annual report of the Secretary of the Treasury, 19x8, p. 38. Digitized by Microsoft® PRINCrPLES AND PRACTICE IN THE WORLD WAR 385 4. Heavy flow of gold to neutrals — Dealers remitted sterling exchange to New York from all parts of the world to make a profit. Although Great Britain restricted the exports of gold, the neutrals were able to evade this restriction by getting gold for their sterling in New York. As a result, there was a very heavy outflow of gold during July, August, and September, 191 7, to the countries where the dollar was artifically depreciated. This movement was in conformity with economic law but defeated the Allied aim. To sustain her exchange rate in New York, Great Britain had to borrow money there and it was to her interest that gold should remain in the United States and thus maintain an easy market. • On the other hand officials of the Treasury and of the Federal Reserve Board realized that the gold holdings of the United States were being depleted to settle for the excess of imports of the Allies.^' c. The Effect on the United States — 1. Depreciation of dollars — The New York rate reflected the effects of the "peg" on the Allied and neutral currencies described above. They are summarized briefly here. The Allied exchanges were supported at an artificially high level in New York, the neutrals bought the depreciated pounds, francs and lire in their own markets and sold them in New York. Great Britain was the pivot of arbitrage operations in New York. American dealers obtained neutral currencies through Great Britain and the neutrals sold much sterling in New York. 2. America paymaster for the Allies — New York set- tled for all the Allies. The world's balances of sterling, francs and lire were transferred to New York. Restrictions by the Allied powers on the exports of gold narrowed the market for settlement of gold balances to New York. As a result, as described above, there were very heavy gold exports from the United States, the excess of which over imports amounted to about $ioo million, "A full discussion of the effects of the "peg" on neutral exchange is found in hearings before the Committee on Banking and Currency of the United States Senate, 65th Congress, ad Session; on S. 3928, "A Bill to Amend the Federal Reserve Act and Create a Federal Resetve Foreign Bank." (Washington: Government Printing Office, 1918.) Digitized by Microsoft® 386 INTERNATIONAL FINANCE AND ITS REORGANIZATION during July, August, and September, 191 7.*' The distribution of exports by countries was as follows: Gold Exports from the United States in 1917 (in million dollars) Country July August September Soain 20 7 37 3 IS 4 20 3 10 South America r India -z 3. Gold embargo — This gold movement was contrary to the individual interests of Great Britain, the United States, and of the other Allies, for some of the gold exported might ultimately reach the enemy powers. To check the outflow an embargo was declared by the President on September 7, 1917, and further exports were licensed and put under the regulation of the Federal Reserve Board. 4. COMJWERCIAL EFFECTS OF THE "pEG" ^As a tesult of thc "peg" the American merchant received fewer pounds sterling for his goods or less of British goods in exchange than he would other- wise have received. However, in American currency, the exporter selling goods abroad received the same number of dollars for his merchandise regardless of where it was sold. The price was deter^ mined internationally and was the same for all purchasers, whether in countries with appreciated or depreciated currencies. However, purchasers whose currency was "pegged" were able to buy more American goads than if it were not "pegged." This was desirable as a war policy. The Allies had to have munitions of war. But it was not desirable that the Allies should be able to buy non- military supplies in the American market at an advantageous rate. However, the War Trade Board restricted the export of non- essentials and this advantage to the foreigner was eliminated. By lowering prices in terms of "pegged" currency, the "peg" tended "Annual Report of the Secretary of the Treasury, 1917, p. 26, Annual Report of the Federal Reserve Board for 1917, p. 20. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 387 to increase the demand for American goods, and thus raised prices in the United States. The American importer paid more dollars for goods from Great Britain than if sterling had not been "pegged." For the same reason, he paid more in dollars, or in dearer guilder for Dutch goods. So far as the imports were essential, the prices of Allied and neutral goods were raised to the American consumer by reason of the "peg" of the pound sterling, and the Allied supply houses received money of a larger purchasing power than their own. The same applies to the neutrals. iii. Correctives of the Depreciation of the Dollar on Neutral Markets a. Proposed correctives — The depreciation was undoubtedly disturbing to the commercial interests in the United States. Dis- regarding the vital fact that military considerations were primary, a few merchants with the aid of a senator proposed several in- feasible measures to correct the depreciation of the dollar in the neutral markets.^^ I. The PROHIBITION OF ARBITRAGE — ^To Correct the deprecia- tion of the dollar, it was proposed that the sale by neutrals of the pound sterling for dollars be prohibited and that the merchants of neutral countries be compelled to buy dollars with their native cur- rency. In view of the fact that the United States had an excess of exports in its trade with most neutral countries the prohibition of arbitrage would have changed the discount on the dollar to a premium in these neutral countries.'''' The proposal would have proven unworkable, as W. P. G. Harding, Governor of the Federal Reserve Board, indicated in his testimony.'^ " The prime mover behind this propaganda was an American importer who was short of neutral exchange on a rising market. "This proposal was sponsored by Senator Robert L. Owen, Chairman of the Committee on Banking and Currency in the 6sth Congress and solely as a war measure by some business men, notably Mr. Leopold Frederick, Treasurer of the American Smelting & Refining Co. It was quoted with approval in an editorial in the New York Times, June 30, 1918. "Hearings on 8.3928, 65th Congress, zd Session, Government Frintmg Office, Washington, 1918, p. 353. Digitized by Microsoft® 388 INTERNATIONAL FINANCE AND ITS REORGANIZATION He pointed out that the United States could not apply this remedy because of the lack of control of exchange dealings in foreign countries. The United States could prevent a Spanish exporter from selling sterling in New York, but it could not prevent his London agent from selling pesetas for sterling and then selling sterling in New York. The proposal would have lessened the use of the dollar as a medium of exchange and increased the exchange transactions in London. The proposal to prohibit arbitrage was similar to an alternative plan to compel American exporters to sell their goods in the currency of the neutral country. In view of the fact that the United States' exports to neutrals exceeded the United States' imports from neutrals, there would have been an abundance of neutral exchange in New York. The amount might have been adequate to furnish dollars to settle for American imports, but not to settle for the combined Allied excess of imports from the neutral countries, which was the basis of the inter-Allied financial unity. Both these proposals might have controlled the depreciation of the dollar but the harm resulting would have been far greater than the good accomplished and the prohibition would have been detrimental to our foreign financial position after the restoration of peace. It was fortunate that the United States did not have to resort to either of the proposed remedies.'^ 2. The TAX ON exports to neutrals — ^Another proposal was to place a tax on all goods exported to the neutral countries, the rate being equivalent to the premium on the neutral currency or the discount on the dollar. This proposal was economically unsound, diplomatically impracticable, and politically impossible. Export taxes are prohibited under the Constitution. 3. A Federal Reserve foreign bank — ^Another remedy pro- posed was the establishment of a Federal Reserve foreign bank, whose powers should be identical with those allowed to the Federal Reserve Bank, under Sec. 14, a, b, c, and d of the Federal Reserve Act, including the power to deal in gold and silver, coin and bullion, to buy and sell bonds and notes of the United States and foreign governments with maturity not exceeding six months "Annual report of the Federal Reserve Board for 19x8, p. 55. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 389 from the date of purchase, to buy and sell bills of exchange, and to establish rates of discount.'* The proposal met with strenuous opposition on the part of leading bankers and students of finance. They pointed out that the bank would serve no purpose which could not be accomplished by the existing organization and that it would embarrass nego- tiations with foreign treasuries then under way. The stabilization of foreign exchange by the British government was effected not through new mechanism, but through the application of accepted methods, namely the shipment of gold, loans, and the resale of securities in the market where the pound sterling was depreciated. The attempt to stabilize exchange by any other methods is artificial. Exchange rates are indicators of economic conditions. Differences of exchange rates reflect the trade balances both visible and invisible, as well as the condition of the credit of the country and the effect of various methods of war finance.'''* It is idle to try to equalize exchanges unless it is possible to control the differences in the credit of the nations, their gold reserves and their methods of finance.'''* b. Fundamental difficulty — ^The prime aim during the war was to win the victory. In the pursuit of this aim the United States government permitted the "pegging" of the Allied ex- changes in New York. American commercial interests in the neutral countries were somewhat unsettled in consequence of tying the dollar to the depreciated Allied currencies. The United States alone could not settle for the excess of imports of all the Allies. I. Impossibility of trade settlement — ^The commercial policy of all the belligerents was determined by military considera- tions. The aims of the war trade policy of the United States were (a) the conservation of domestic supplies for the use of the United States and of the Allied nations (b) prevention of trade directly or indirectly by persons in the United States with, for the benefit of, or in behalf of the enemy or its agents (c) conservation of tonnage for the transportation of military necessities for the " 8:3938, 6sth Congress, 2d Session, introduced by Senator Robert L. O'wen of Oklahoma, Chairman of the Committee on Banking and Currency. "A clear statement of the difficulties in leveling the international exchanges is contained in the annual report of the Secretary of the Treasury for 1919, p. 13. See also Finance in the War, address to Na- tional Foreign Trade Council, April 18, 1918, by Fred I. Kent, Director, Division of Foreign Exchange, Federal Reserve Board. Digitized by Microsoft® 390 INTERNATIONAL FINANCE AND ITS REORGANIZATION United States and the Allies." The war trade policy was con- cerned less with keeping dollar exchange at par in the neutral countries (which were a minor factor even from the commercial point of view) than with maintaining an adequate supply of es- sential materials for the United States and the Allies. Only after the satisfaction of these requirements was any surplus to be made available for consumption in neutral countries. 2. Unavailability of securities — ^Another method of set- tling for an excess of Allied imports was by means of securities. To accomplish this aim it would have been necessary for the United States to contract loans in the neutral countries equal to the extent of the combined excess of the imports of the Allies. This obviously was impossible. 3. Insufficiency of gold — Similarly the United States could not ship gold to settle for the Allied excess of imports. There was not enough gold in the United States to make such a settlement feasible. In short, the military policy made it im- possible for the United States alone to utilize any of the accepted means of settling a trade balance or of righting a depreciated exchange. The movement of commodities was restricted by the War Trade Board in the interests of military policy. The United States could not borrow in the neutral countries or sell them securities in sufficient amount to balance the combined excess of imports of the Allies. Nor could it ship gold for this purpose. c. Correctives in effect — ^The officials of the Treasury and of the War Trade Board of the United States realized the difficulties of the situation.'* Subject to the limitation of tonnage and other war requirements, it was most important to pay our adverse foreign balances through the export of commodities otherwise nonessential, and this consideration was urged upon those departments of our Government having such matters in hand. "Report of the War Trade Board, pp. 12-13, Washington, Govern- ment Printing Office, 1920. "Annual Report of the Secretary of the Treasury, 1918, p. 38. Testimony of Assistant Secretary R. C. Leffingwell before the Wajrs and Means Committee of the House on the amended Second Liberty Bond Act, September 12, 1918. Federal Reserve Bulletin, October, 1918, p. 94a. A brief summary of these operations is given in an address on the Federal Reserve System, at Princeton University, January 21, 1921, by Albert Strauss, sometime member of the War Trade Board, representing the Treasury, and Vice-governor of the Federal Reserve Board. Digitized by Microsoft® PElNCrPLES AND PRACTICE IN THE WORLD WAR 39I While the United States supported the exchange of France, Great Britain and Italy, exports were almost equally valuable from a purely exchange standpoint, whether made by the United States or by such countries. Those countries have been importing vastly more than they could export, so there was ample tonnage for any exports they were able to make. The need for tonnage for carrying war supplies from the United States was so great as to make it difficult to provide shipping space for exports from the United States to European neutrals that did not own shipping. The matter of exports to European neutrals contiguous to the central powers, whether or not they owned shipping, was controlled by considerations of blockade. The possibilities of exports to the other parts of the world were limited to the outward voyage of the tonnage required to bring back needed imports to this country. Foreign loans and credits constitute a means of temporarily re- lieving the exchange situation and by postponement afford an oppor- tunity to obtain relief by means of proper trade measures. The Treas- ury has urged upon the Governments of the Allies the necessity of their obtaining neutral currencies through loans or credits or the sale of the foreign securities which they held. The Treasury also itself effected arrangements for stabilizing exchange in a number of neutral countries. The only effective remedies available were credits from the neutrals, borrowing not only by the United States, but by all the Allies. International cooperation was as necessary in correcting the exchanges as it was in "pegging" the exchanges. I. Borrowings by the United States— a. The law — Recognizing the need for correcting the ex- changes by borrowing abroad Congress enacted legislation for this purpose. Section i6 of the Second Liberty Loan Act authorized the Secretary of the Treasury to issue bonds or certificates of indebtedness payable, principal and interest, in any foreign currency, and he was authorized to designate depositaries in foreign coun- tries with which the proceeds might be deposited. Section 4 of this Act, as amended, authorized the Secretary of the Treasury during the war and for two years after its termination to make arrangements in or with foreign countries to stabilize the foreign exchanges and to obtain currencies and credits in such countries for this purpose. The War Finance Corporation Act also contained a clause inserted at the request of the Treasury Department, which author- ized the Corporation to issue bonds payable in foreign money or payable at the option of the holders either in dollars or in foreign money, at a fixed rate of exchange. Digitized by Microsoft® 392 INTERNATIONAL FINANCE AND ITS REORGANIZATION b. Loans negotiated — I. Neutrals of Europe — *. Spain — ^A group of Spanish bankers opened a credit about $48 million, in favor of the United States, Spain was assured of her necessary supplies of cotton and oil, the amount being fixed at such a figure as would cover the minimum Spanish requirements but would prevent "future" pur- chases by German agents. On the other hand the United States forces in Europe received immediate delivery of 200,000 woolen blankets, 20,000 tons of leather, 100,000 tons of chick peas, and other military necessities. Furthermore, American credit assisted the French government in securing additional credit in Spain. The Bank of Barcelona, and the Bank Urquijo granted the loan on September 7, 191 8, under the following conditions: The maxi- mum amount of the credit was about 250 million pesetas to be drawn between October i, 1918, and July i, 1919, at a rate not exceeding 50 million pesetas monthly. The credit was in the form of bills of exchange drawn by American bankers against the Spanish banks in the syndicate. Payment was to be made at maturity either in pesetas or in gold coin or bullion at parity. If the Spanish banks should not accept payment in gold because the Bank of Spain refused to receive it at par, the bills would be ex- tended for six months in order that settlement might be in peseta bills. As a condition of the loan equivalent amounts of American bonds were to be deposited payable in pesetas or in gold and with the same maturity as the bills of exchange.''^ As security for the credit between the banks the Treasury De- partment furnished certificates of indebtedness payable in pesetas. The total amount of private credits drawn and public obligations sold amounted to 155 million pesetas. As Spanish exchange de- clined, the Treasury Department reduced its obligations to 80 mil- lion pesetas by purchases in the exchange market at parity or less.'* On February 28, 1920, the certificates of indebtedness were com- pletely paid for at a substantial profit to the government because pesetas had declined below parity. This is the only foreign indebt- edness incurred by the United States during the war.'* "London Economist, Sept. 28, 1918. "Report of the Secretary of the Treasury, 1919, pp. 66-67. "Annual Report of the Secretary of the Treasury, 1920, p. 67. Digitized by Microsoft® PRINCiPLES AND PRACTICE IN THE WORLD WAR 393 y. Switzerland — ^Arrangements were made whereby Switzer- land placed at the disposal of the United States Treasury about 75 million Swiss francs in return for dollars at par, although dollar exchange was at a discount in Switzerland. The object was to per- mit the purchase in Switzerland of goods necessary for the Ameri- can Expeditionary Force. Limitations were set as to the time and amount of advances, which were restricted to government purchases. z. Scandinavian countries — ^Arrangements were also made with Norway and Sweden. They did not open a credit in favor of the United States Treasury, but they did permit the proceeds of exports from the United States to Norway and Sweden to be deposited in dollars at par in the national banks of Norway and Sweden for the use of the Federal Reserve Bank of New York. The War Trade Board, on the other hand, granted export licenses on shipments con- signed to Norway and Sweden only on the condition that the pro- ceeds would be so deposited. The effect was to give the United States currency purchasing power at parity and thus lessen the premium on kroner in New York or the discount on dollars in Norway and Sweden. The stimulus on exports in the United States and the check on exports from Norway and Sweden were thus removed. 2. Neutrals of South America— The depreciation of the dollar in South America was due not only to the "pegging" of exchange and to the combined excess of imports of the Allies from the South American countries, but more directly to the excess of imports by the United States alone. In 1917 the excess of imports of the United States from Argentina was $70 million. In 19x8 it was $122 million. The excess of imports of the United States from Chile in 1917 was $86 million and in 1918 $100 million. The total trade of these countries showed a large favorable balance. Argentina had an excess of exports equivalent to $20 million in 1916, and $164 million in 1917. Chile had an excess of exports in the same years equivalent to $106 and $130 million, respectively.*" As a result of both the American and Allied excess of imports from these countries, dollars depreciated in South America. X. Argentina — In January, 19 18, an arrangement with the Ar- gentine government was effected whereby the exchange between the two countries was stabilized. Under the arrangement Ameri- can importers owing money to Argentine merchants paid it to the *" International Commerce and Reconstruction, pp. 332-334. Digitized by Microsoft® ' 394 INTERNATIONAL FINANCE AND ITS REORGANIZATION Argentine Ambassador In the United States, who deposited the amount with the Federal Reserve Bank in New York. The Ar- gentine government on its part agreed that the accumulated balance on this account need not be shipped in gold until the Treaty of Peace had been ratified and on its part the American government agreed to interpose no obstacle to the necessary gold exports. The amounts deposited with the Federal Reserve Bank included an additional 3 per cent to cover the cost of anticipated future gold shipments. The original amount of the credit was $40 million.*^ In March, 19 18, this credit was exhausted and subsequently in- creased to $100 million.*^ y. Other South American Countries — ^An arrangement similar to that with Argentina but limited to $5 million with an agreement to extend it to a total of $20 million, was concluded with Bolivia. A credit of $15 million was opened with Peru, in order to avoid the shipment of gold from the United States during the period of the embargo. The arrangement called for a premium of 3 per cent, to cover the future charges for shipping of gold. Exchange on Peru was obtainable by American importers by making a deposit of dollars with the Federal Reserve Bank of New York to the credit of the Junta de Vigilancia de la Emision de Cheques Cir- culares of Peru. Upon receipt of such deposit, commission, cable charges, and guaranty, the Federal Reserve Bank cabled the Peru- vian bank to pay the equivalent of the deposit in Peruvian funds to the party in Peru designated by the depositor. The rate was $5.oij4 for each Peruvian pound, or a premium to cover the cost of shipping gold of 3 per cent above the parity of $4.8665.*' Similar arrangements were effected with Uruguay, and nego- tiations with Chile were under way but were never completed. 3. Japan — Before the United States placed an embargo on gold exports, the settlement of the Allied excess of imports from Japan was effected by means of gold shipments from the United States. When the embargo went into effect Japanese holdings of Allied exchanges accumulated in New York. In September, 1918, the Japanese government issued exchequer bonds to the amount of 100 million yen, equivalent to $50 million, for the purpose of buying the " United States Treasury announcement Jan. 8, 1918, reported in the press. ^^ Hon. R. C. Leffingwell's testimony, ibid. "Federal Reserve Board announcement, Dec. a6, 1918. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 395 foreign bills held by Japanese subjects." The amount of dollar exchange kept on accumulating and in June, 1919, the Japanese government bought $130 million of United States treasury certif- icates of indebtedness with the funds obtained by the purchase of dollar exchange from its subjects. These treasury certificates did not constitute a special issue as in the case of Spain. 2. Borrowing by the Allies — a. Spanish loans to France — But borrowings by the United States could not settle for the combined excess of imports of the Allies. The problem was not American; it was international. This was made clear in the hearings on question of establishing a Federal Reserve foreign bank. Witnesses versed in finance tried to show the advocates of an exchange bank that the United States alone could not hope to solve the problem that the cooperation of all the Allies was required. The United States Treasury officials urged upon the Allies the importance of opening credits in the neutral countries in which their exchanges were depreciated. The credit negotiations between the United States and Spain were merely part of general negotiations of the Allies with Spain. A trade agreement between France and Spain provided for the move- ment of special commodities of which Spain had a surplus and the importation into Spain of commodities of which there was a shortage. On the other hand a group of Spanish bankers agreed to open a credit in favor of a group of French bankers for an amount not to exceed 350 million pesetas.*' This credit remained iinpaid in December, 1920. England likewise borrowed extensively in Spain. b. Argentine loans to the Allies — In January, 1918, Argentina opened a credit in favor of Great Britain and France to the extent of $200 million payable in two years. The credit was to cover the exportation of wheat, corn, oats, flaxseed, and beef. The large advances, running into billions, by the United States government undoubtedly influenced Argentina's position in the matter.*^ After the war Great Britain, France, and Italy applied to Argentina for ^Announcement of the Financial Commission in the United States of the Japanese Government, Sept. 23, 1918. "^ For a discussion of the financial and commercial aspects see Inter- national Commerce and Reconstruction, pp. 78-80. "Argentine correspondence of the London Economist during January, 1918. Digitized by Microsoft® 396 INTERNATIONAL FINANCE AND ITS REORGANIZATION a loan of 200 million pesos. Although the convention was signed the Argentine Senate refused to ratify it and after many changes the form of the loan was changed in a manner unacceptable to the borrowers.*' (d) The Effects on Rates — The effect of borrowing by the United States and by the Allies was to lessen the premium on exchange. Undoubtedly the military events preceding the final collapse of Germany had a potent in- fluence in accelerating the reduction of the premium of the Allied currencies in the neutral market. The highest premium attained in July, 1918, and the premium on November 15, 1918, are given in the table below. Pkemium on the Neutral Exchanges *' Currency of- Highest premium, July, 1918 Per cent Premium, Nov. 15, 1918. Per cent Sweden . . . . Norway Denmark. . Holland. . . Switzerland Spain India Japan Argentina. . CWle Peru Bolivia 33-58 17.91 16.79 29-35 31-50 42.7s 10.14 7.82 S-61 75-84 20.83 8.84 3SS 1.68 0.7s 3-86 3-21 3-63 10.14 9-33 S-04 31 -S4 3.10 1.54 G. The Abandonment of Stabilization Expedients i. Decontrol of Exchange The release of the support of sterling exchange took place first in Spain in February, 19 1 9. This step was followed by the abandonment of the support of francs by Great Britain in London, on March 18, 1919. The violent fluctuations indicated similarly an abandonment of sterling in New York. On March 20, 1919, "Commerce Reports, April 19, 1919 and Argentine correspondence of the London Economist, Oct. 11, 1919. "Annual Report of the Secretary of the Treasury for 1918, p. 38. Digitized by Microsoft® PRINCIPLES AND PBACTICE IN THE WORLD WAR 397 Mr. J. P. Morgan announced "we have received instructions from the British government to suspend purchases of sterling exchange for government account." On March 21, 1919, the support of lire in New York was modified and shortly thereafter abandoned. Mr. Fred I. Kent, Director of the Division of Foreign Exchange of the Federal Reserve Board, announced that "all restrictions as to the sale or purchase of lire exchange by dealers are J^ereby removed." The Italian Institute of Foreign Exchange, organized at the time when control of the quotation of the lira was under- taken, still continued to operate and for a few days there were two conflicting quotations in the market, an official quotation of the institute and a quotation of the free market. The advances of the United States government were not officially part of the mechanism for stabilizing exchange and they continued for about a year. The Secretary of the Treasury announced that after March 10, 1920, no further credits would be opened by the United States government in favor of the Allies. Between March, 191 9, and March, 1920, the United States government established new credits amounting to about $IOO million. ii Reasons for Release of the "Peg" a. Inability to Obtain Credit — The immediate reason for the release of the "peg" was the inability of the European nations to obtain further credit. The Bank of France ceased to sell sterling exchange at fixed prices because of the exhaustion of its credit in Great Britain. The British government withdrew the credits which it had advanced to the French government and which the French Treasury turned over to the Bank of France for the use of French importers. After the armistice, the United States government advances were further extended only for the purpose of liquidating war con- tracts, and for the sale of wheat, the price of which was guaranteed by the government, and for purposes of relief. b. The "Need for Return to Normal Conditions — Except for the support of lire exchange in New York by the United States, the stabilization of exchange was Britain's burden chiefly. Great Britain advanced credits to the other Allies to support Digitized by Microsoft® 398 INTERNATIONAL TINANCK AND ITS REORGANIZATION their exchanges in London. Likewise it was Great Britain that raised loans and floated treasury bills in New York for the purpose of stabilizing sterling and indirectly the other Allied currencies. Furthermore, the control of the exchanges was interrelated with the control of exports and imports. Upon the release of the control of trade movements, it was more difficult if not impossible to con- tinue to stablize the exchanges which were dependent upon them. Great Britain did not wish further to support the Allied exchanges in view of the large imports of luxuries and non-essentials. Con- tinued support would have meant a cost-of-living subsidy to the continental Allies at the expense of the British Treasury. Again the large speculative operations became more difficult to control after the war, and upon the decontrol of exports and imports, speculation intensified the fluctuations of the exchanges. One of the amusing aspects of the release of the "peg" was the conflict of reasons offered by the press. One explanation was that the release of the "peg" was due to a new commercial policy adopted by France, whereby depreciation of the franc would check imports into France and stimulate exports. A few days later the financial editor of the Journal de Debats stated, "If the British government will not grant France direct advances, France will be obliged to purchase elsewhere, in countries which are prepared to open credits in our favor." A year and nine months later, December 22, 1920, the French press chided the United States for failure to extend further credit, thus causing stagnation in Europe. iii. The Effects of the Release of the "Peg" As a result of the release of the "peg" exchange rates again became accurate financial indicators. They registered truly and for each country alone the effect of adverse trade balances, of the decline in the invisible credits, of the existence of large foreign debts, of the huge increases in paper currency, and of all the factors which operated to depreciate the Allied exchanges in New York. The presentation of a true picture of the unsound financial condition of Europe was the first step toward a restoration of normal con- ditions. Inequalities in exchange indicated not only the balances both visible and invisible between countries but also differences in their financial condition. The varying proportions of taxes to loans in financing the war, the resort to unsecured note issues of Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 399 the government or of the central bank of Issue, the measures taken to balance the budget and to deflate the currency, all were reflected in the rate of exchange. Some months after the release of the "peg" interest rates were raised in Great Britain. Only the desire to make easy the transition from war to peace kept the Bank of France from raising its discount rate until April, 1920. a. The Sharp Decline of the Exchanges in New York — ■ One of the early manifestations of the release of control was the disparity between rates for dollars in London and sterling in New York. During the period of control the difference was neg- ligible. Furthermore, upon the announcement of the abandonment of the support of sterling by the British government the cable rate which had been maintained at $4.76^ dropped to $4.70. Sight drafts fell to $4.67 and the following day to $4.60. For months after the release of the "peg" the newspaper headlines read daily, "Further Declines in Exchange," "Violent Breaks," "New Low Levels," "Lowest Level in the Century." The ex- changes continued to decline throughout the year and into 1920. Not only did the Allied exchanges, which had been supported, High Monthly Demand Quotations m New Yoke s' (Gold parity =100) Currency Feb., 1919 Dec, 1919 Oct., 1920 Belligerent Sterling . Francs.. Lire .... Neutral Swiss francs. . . Guilders Danish kroner. . Swedish kroner. Pesetas Argentine pesos. Chilian pesos 97.78 94.92 81.4s 106.74 102,61 97.48 105.04 109-33 106.19 108.78 81.94 52.23 41.97 94. 20^^ 95 -IS 74-25 83-21 103. II 102.11 105.05 72.07 34-97 21.66 83.26 77.26 52-43 74-25 75-96 85-77 85-11 •November quotation. December quotation is out of line -with the preceding and following months, "Federal Reserve Bulletin, Nov. 1920, pp. 1159-1160. Digitized by Microsoft® 400 INTERNATIONAL FINANCE AND ITS REORGANIZATION decline greatly, but the neutral exchanges which had been at a premium during the period of control declined below par. The same effects are shown in the high and low quotations for 1919. The high quotations were attained in the period prior to the release of the "peg." Cable Rates of Exchange '" Currency Parity High, Low, High, 1919 1919 1920 I4-866S $4,761^ $3 -665 $4-075 •1930 .1837 .0852 ■0933 .1930 • IS7S .0736 .0758 .1930 .2092 .1718 .1836 .4020 •4287s •36875 •3025 .2680 .27125 • 173s .1920 .2680 • 293s .2065 .2230 .2680 .2825 •1950 .20SS Low, 1920 Sterling Francs Lires Neutral Swiss francs I Guilders I Danish kroner. . . ; Swedish kroner. . . Norwegian kroner l3^i97S .0571 .033s .1508 ■2935 •130S .178s .1305 b. The Effect on Trade — The fall of the exchanges checked European imports of non- essentials, for as the franc depreciated, the French importer had to pay an increasing price for the foreign goods. If the goods were dispensable the increasing premium checked imports, just as a domestic rise in prices checks purchases. However, some imports are indispensable; people must have food and raw materials for clothing and shelter. The effect of "unpegging" was to raise the prices of essential imports and thus increase the cost of living. The index numbers of wholesale prices in France rose from May onward continuously throughout 1919 and through a good part of 1920, simultaneously with the fall of the exchanges. The following table gives the monthly high demand rate for francs in NewYorfc in terms of gold parity as 100 and the French index number of whole- sale prices, using the 1913 average as 100. Of course, rising import prices were not the sole factor in causing a rise in general prices. Both rising prices and falling exchange were due to increase in the note circulation. " New York Times Annalist, Jan. 3, 1921. Digitized by Microsoft® PRINCIPLES AND PRACTICE IN THE WORLD WAR 401 The Decline of Exchange Rates and the Rise of Wholesale Prices '^ Mbntb , Monthly high demand rates for francs in New York, Per cent of parity French wholesale index numbers, 1913 = 100 1919 94-97 94-92 94.82 88.13 85-34 82.64 79.79 70.98 66.27 62.14 S8.60 52.23 48.08 38.76 39-17 3S-91 41-19 43-47 348 ^40 March ^^7 %%2 ' May ^2"; 329 July ^40 347 September October 360 382 November. - 40? Deceisber .^ * 4.2? 1920 Tanuarv. 487 <22 3\4arch K^^ April. ...f ■184 May ^■;o June , . ., 493 The rise in the cost of living unsettled international trade and made the manufacture of imported raw materials a speculation in exchange. TTie fall in exchange stimulated exports. These included both raw materials and manufactures. When the decline was particu- larly rapid, exports boomed and on a temporary improvement, exports declined. This fluctuation of prosperity and depression was particularly striking during the sensational decline and slight improvement in German exchange. The resulting unsettled condition of business affectea not only ftie countries whose currencies were depreciated but also the non- European countries. After Europe had purchased the minimum quantity of indispensable goods necessary to restore her depleted stocks, the United States, Argentina, Brazil, Chile and Japan all suffered from the stagnation of industry after the middle of 1920 because of the diminishing excess of exports over imports. The " Federal Reserve Bulletin, Aug. 1920, p, 842 and Nov. 1920, p. 1159. See also above, Figures XXI and XXII on pp. 340-1. Digitized by Microsoft® 402 INTERNATIONAL FINANCE AND ITS REORGANIZATION diminishing imports of the countries whose currencies were de- preciated resulted in a decline of prices and a surplus of goods in the great sources of supply of raw materials. M. Loucheur, former Minister of Commerce, addressing the Chamber of Depu- ties, December 22, 1920, blamed America and England for the world-wide stagnation of industry. "Forty or fifty billion francs of additional credit in America and England would have stabilized the credit of the world. The hour has come to show them the error of their policy and the necessity of reopening government credits. Even if we are their prisoners they cannot abandon us." (c) The Effect on the Gold Market — Upon the release of the "peg" the currencies of the neutral countries declined in New York, and their demand for gold in New York in settlement of their excess holdings of the Allied exchanges ceased. Accordingly, on June 9, 19 19, the Federal Reserve Board announced that control over the exportation of gold would be terminated. Because of a lack of an excess of exports to the United States, and a resulting lack of dollar drafts the neutral countries of Europe were unable to withdraw gold from the United States. There was, however, a heavy flow of gold during the year 19 1 9 to the countries of South America and the Far East, in the trade with which the United States had an excess of imports. The case of Argentina was typical. Upon the removal of the embargo on June 9, 1919, gold shipments began and continued heavily throughout the rest of the year. The excess of commodity imports from Argentina into the United States in 19 1 9 was $43,000,000. However, during that part of the calendar year 1919 when gold was free to flow, the excess of gold exports from the United States to Argentina was $56,000,000. During the early months of 1920 heavy gold shipments continued.°^ During the fiscal year 1920, ■"A curious factor in the exportation of gold to Argentina was the refusal of American bankers to renew the 50 million 6 per cent s-year treasury notes, which matured May 15, 1920. The outflow of gold could have been checked by collecting this loan on maturity or else by borrow- ing in Argentina. The Argentine government would not let the American bankers settle for their excess of imports with the maturing treasury notes because of the difficulty of that government in re-financing internally. Strange to say British bankers undertook to refund the loan and obtained $50 million of gold in the American market which was shipped to Ar- gentina on British account. Digitized by Microsoft® PRINCIPIES AND PRACTICE IN THE WORLD WAR 403 during most of which gold flowed freely, about $146 million of gold was sent to Argentina. The depreciation of the dollar in Argentina soon corrected itself and the Argentine excess of exports to the United States began to decline in June, 1920, and by August there was an excess of imports from the United States. As a result the gold flow was reversed. In accordance with the credit agreement, mentioned above, the Federal Reserve Bank of New York had received gold and credited it to Argentina. The maximum amount was $72,- 500,000. Toward the end of May, 1920, the Argentine govern- ment released in New York $4,500,000 in favor of American exporters and continued to release gold in large quantities until July 10, 1920, when only $28,420,000 remained on credit to the Argentina government. Dollars rose to a premium in Argentina and on July 24, 1920, the Minister of Finance of Argentina ordered the Banco de la Nacion temporarily to cease accepting deposits of gold which called for equal withdrawals in the United States. As the embargo was declared pesos declined to a discount of 10 per cent. On October 11, 1920, the gold holdings in the United States to the credit of the Argentina government were exhausted and peso exchange declined further to a discount of 22j4 per cent and on November 15, 1920, to a discount of 28 per cent. Heavy gold shipments from all countries to the United States were resumed after the release of the "peg." ^^ (d) The Continued Liquidation of Securities — Upon the release of the "peg" the flow of securities was again resumed. Again, the flow of securities acted as a corrective. The resale of the European holdings of American securities began again in large volume. Furthermore during this period American pur- chases of foreign internal securities, both government and indus- trials, ran to high levels. The decline of exchange also resulted in the accumulation of large balances of European exchange and currencies upon the part of American investors which they were ready to sell upon a rise and which thus tended to check any im- provement in the exchanges.. The European countries both Allied and neutral, whose currencies were depreciated in New York, " Commerce Reports, Nov. 19, 1920, p. 787. Digitized by Microsoft® 404 INTERNATIONAL FINANCE AND ITS REORGANIZATION borrowed heavily in the New York market. As a result of the decline of the European exchanges after the release of the "peg" Europeans were less inclined to purchase American securities for purposes of evading their home income tax. The decontrol of the exchange had a sobering influence on the finances of Europe. The ways and means advances in Great Britain were subsequently brought under control and the notes of the Bank of France ceased to increase. They reached their maximum amount in 1920. The effect of the decline in exchanges, resulting from the release of the "peg," was to check further inflation and unsound methods of post-war finance. Digitized by Microsoft® CHAPTER X BRITISH FOREIGN EXCHANGE A. Causes of Depreciation 1. The Nature of the Fluctuations — ^The pound sterling rose on the exchanges of France and Italy. In the United States it declined, was stabilized during the War, and declined further after the release of the "peg." On both the Argentine and Japanese markets it depreciated after 1915. In the neutral countries, Switzerland, Holland, and Sweden, the pound sterling at first declined greatly but was supported somewhat as the result of the "peg" of sterling in New York; it rose after the release of the "peg" of francs and lire in London. On the exchanges in China and India the pound sterling declined, first on account of the increased excess of British imports and then owing to the violent rise in the price of silver. Extent as ihe Decline of the Pound Sterling on the Important Exchanges' (as of July each year) France Italy U.S. Argen- tina Japan Switzer- land demand Holland Sweden China India cable rate. demand demand demand demand cables demand demand cable Year rate, rate, rate, rate, rate, rate, rate. rate. francs Jfe«, dollars pence per yen rate, francs per £ guilders kroner pertael per per £ pet£ per £ per peso, s. d. per £ per £ s. d. rupee, s. d. 1913 iS-^S 25.97 4.S68 48.2 2 0.4 25.30 12.13 18.2s 2 8 I 3.9 1914. 25.15 25.265 4.876 47-7 2 0.4 25.20 12.12 18.26 2 6.2 I 4.0 1915 27.25 29-55 4.762 48-4 2 0.6 26.05 12.00 18.25 2 3-1 I 3.8 1916 28.145 30.40 4-757 48-9 2 2.1 15.27 11.50 16.40 2 II. 4 I 4-1 1917 27.40 34.55 4-754 SO-S 2 1.7 22.50 11.56 15.60 3 9-7 I 4.2 1918 27.17 43.50 4.753 Si-7 2 2.3 18. 95 9-39 13-45 4 8.2 I 6.0 1919 29-75 36.70 4-S72 51-1 2 2.4 25.00 ir.84 18.00 5 3.0 I 8.0 ii Merchandise Balance of Trade — The basic cause of the depreciation of the pound sterling was a large excess of imports. In 1913 the excess of imports was 'Memorandum of Consul General Hollis, London, Commerce Reports, September 37, 1919. 40s Digitized by Microsoft® 406 INTERNATIONAL FINANCE AND ITS REOEGANIZATION £243 million, and in 1918 £822 million. The total imports, the exports of domestic produce, and the ratio of exports to imports for the years 19 13 through 191 8 are shown herewith: Total Imports and Exports of Domestic Produce ' (in million pounds sterling) Calendar year Total imports Exports of domestic produce Ratio exports to imports, Per cent 1913 1914 1915 igi6 1917 1918 768.7 696.6 851.0 948. 5 1066.7 1320.7 525-2 430-7 384-9 506.3 525-3 498-3 68.3 61.8 45-2 52. 8 49-3 37-8 From 191 3 to 191 8 the ratio of exports to imports was almost cut in half and this fact explains the depreciation of sterling ex- change. If the reexports of foreign and colonial produce be added to exports of domestic produce, the net excess of imports shows a still larger increase. In 19 13 the net excess of imports was £133.9 million and for the year 1918 it was £789.9 million. The actual excess of imports and the relative figures,"" based on returns for 1913 as 100, are given herewith: Net Excess of Imports ' Year Excess of imports Relative figures. (in millions sterling) 1913=100 1913 133-9 100 1914 170.4 128 1915 367-9 275 1916 344-6 257 1917 467.4 349 1918 783.8 585 1919 669.3 Soo 1920 378.8 283 'International Commerce and Reconstruction, p. 154. 'Official returns of the British Board of Trade. Digitized by Microsoft® BRITISH FOREIGN EXCHANGE 407 The excess of imports rose in 1918 to a high level of almost six times the pre-war figure and the increase accounts directly for the depreciation of sterling. iii. The Decline of Invinble Credits The pre-war investments of Great Britain were estimated to be £4000 million and the annual income £200 million. Paish estimated that £1000 million of securities were liquidated, re- ducing the annual income by £50 million. Furthermore, Great Britain borrowed £iOOO million abroad,, which created an annual invisible debit of £70 million. The effect of the war, then was to reduce the pre-war income from investments from £200 million to £80 million. As an offset to her borrowings abroad, Great Britain loaned to her Allies £1739 million, the income from which ought to be about £90 million. However, Great Britain is the debtor of financially strong countries and is the creditor of finan- cially weak ones and it is a question whether the net annual income from investments will rise much above £80 million for some time. In an approximation of the invisible balance after the war, the British Board of Trade increased the estimate o£ income from shipping from the pre-war figure of £130 million to £500 million as a tentative estimate and £440 million as a final estimate. Even if we disregard the increased income from shipping, the total British balance of trade, both visible and invisible, does not seem to warrant the depreciation of sterling that prevailed during 1920. The excess of imports from 1914 to 1918 amounted to about £2140.2 million and the loans to the Allies and Dominions amounted to another £1800 million or a total of about £3950 million. The borrowings abroad and the liquidation of securities as noted above amounted to about £2400 million. The difference, about £1550 million, represents the net excess of debits over credits. The invisible credit balance was increased by borrowings from the United States, which at the time had the same effect as mer- chandise exports in creating a supply of bills on the United States. Conversely, the invisible credit balance was reduced by loans to the Continent which, at the time made, had the same effect as imports into the country. Both an importation of securities and an importation of merchandise create a world supply of bills on London and tend to depress sterling exchange. Digitized by Microsoft® 408 INTERNATIONAL FINANCE AND ITS REORGANIZATION iv. Loans to the Allies (a) During the War — Up to March 31, 1919, the loans to Dominions and Allies amounted to £1739.4 million, distributed as follows: Loans by Gkeat Bbixain * March 31, 1919 (in millions stetliag) iDominioiiS 171.0 568.1 434-5 414-5 86.8 18.6 47-9 Russia France .-.- -* Italy Belgium Servia-.. Other Allies, Total 1739-4 These loans to the Allies were made to finance the purchase of war materials by them and thus to aid in the stabilization of their rates of exchange. (b) After the War— The loans to the Allies after the war included advances made to the debtor Allies for the purpose of postponing payment of interest, as well as new private loans floated in the London market.* There were various methods whereby Great Britain advanced loans to the Continent. In some cases the Continental buyer would deposit his native currency against the British shipment at the cur- rent exchange rate and would guarantee to deposit additional currency to compensate for the decline of his exchange. Again the British would supply raw materials in trust to Continental manufacturers and the property right would be guaranteed by the government. Upon the sale of the goods the British exporter would be reimbursed. Finally, the so-called refining trade was a barter of finished goods for raw materials. The British exporter would send raw materials to the Continent for finishing and retain a lien on the goods in process which would afford increasing security. Upon the completion of the finished merchandise the 'Budget speech of Mr. Chamberlain. 'London Economist, Sept. 6, 1919. Digitized by Microsoft® BBITISH FOREIGN EXCHANGE 4O9 Continental importer would return to the British exporter a por- tion of the finished goods.* Furthermore, loans were raised in Great Britain to pay for imports by the Continent from Great Britain. These loans, both long and short term, account for the rapid increase of exports of Great Britain and the decrease of the so-called unfavorable balance of trade. However, Great Britain sold on credit, but bought for cash and therefore was in possession of a large volume of non-liquid commercial bills which she could not use in settlement for her own imports. As a result, the pound sterling was tied to the Con- tinental exchanges and fluctuated in sympathy with them, in much the same way as during the war the dollar was tied to the cur- rency of the Allies and depreciated with them on the neutral markets of Europe. The loans by Great Britain to the Continent, however, covered not only sales on credit of goods and services but also loans to the Continent for other purposes and the purchase of Continental securities or industries. (c) Sterling Remained the World's Currency — The depreciation of sterling was due to the fact that imports into Europe from the United States were financed by remittances via London. Or in other words, Great Britain provided dollars, with which the Continent settled for its American imports. The ty- ing of sterling and Continental exchanges resulted in the artificial depreciation of sterling and the artificial support of the Continent. As a result the holdings of sterling in New York were very large but the holdings of the Continental currencies were relatively slight. Trading in exchanges, other than sterling, was effected via London. This situation followed from the efforts of Great Britain to increase her exports to the Continent and thus to restore the productivity of Europe. (d) The Palliative Character of Loans — These advances by Great Britain to the Continent did not permanently remedy the situation ; they were palliatives. Like the 'BritisE Trade Corporation's Methods in Jugoslavia, by Consul K. 8. Patten, Belgrade, Servia, in Commerce Reports, Aug. 9, 1920. The Anglo-Danubian Association, Ltd., the New York Herald of April ao, 19ZO. Anglo-Baltic and Mediterranean Bank, Ltd., Journal of Commerce, Apr. 16, 1920. Digitized by Microsoft® 410 INTERNATIONAL FINANCE AND ITS REORGANIZATION government advances during the war, these post-war loans con- cealed the true situation and in that respect were harmful. Upon the withdrawal of London's support, the other European exchanges fell sharplyj Assuming that the British Board of Trade figures for the invisible balance were correct and that the total debits and credits, both visible and invisible, would balance, London exchange should rise if England ceased to support the Continent. By the same token the Continental exchanges should fall if the temporary aid extended by London should be withdrawn, V. Inflation The increase of deposits and of the currency contributed to the depreciation of the pound sterling. If issued excessively, paper money which cannot be converted into gold at par depreciates abroad, just as at home. The increase of ways and means advances, the increase of public and private deposits of the Bank of England, and of private deposits of the joint-stock banks, created a redun- dancy of credit. When prices doubled, the value of the excess of imports of commodities doubled. On the other hand the invisible credits, such as income from investments either increased not at all, or certainly not in the same proportion as the price of com- modities. As a result the commodity debits and invisible credits no longer balanced. A larger demand for bills resulted from the growing value of the excess of imports than could be paid for by the supply resulting from the stationary income from investments. B. The Effects of Depreciation The effects of depreciation have been discussed fully in the chapter on foreign exchange in the United States. To summarize briefly, the effects of depreciation were both commercial and finan- cial. The depreciation of the pound sterling in New York and on the neutral markets increased the cost of British Imports, par- ticularly imports from those countries, in which exchange rates were not "pegged." The stabilization of exchange in New York ' See Par. 3. Final Report of the CunlifiFe Committee, Dec 3, 1919. The subject was discussed in the Chas Economic Bulletin for October, 1920, by B. M. Anderson, Jr. Digitized by Microsoft® BRITICH FOREIGN EXCHANGE 411 kept the cost of British imports from rising. After the war the depreciation of the pound sterling in New York again increased the cost of imports from the United States and for a time increased the general cost of living. On the other hand the depreciation of sterling stimulated British exports. The financial effect of depreciation was to induce selling of British holdings of foreign securities, in those countries in which sterling was depreciated. Furthermore, borrowing by Great Britain was stimulated, particularly in those countries where sterling was at a discount. C. Correctives of Depreciated Exchange The correctives of depreciation included the flow of merchan- dise, the movement of gold, the flow of capital and the improve- ment of fiscal and credit conditions in Great Britain. During the period of the "peg," loans were the chief means of correcting the depreciation of sterling. However, the "peg" was finally removed in March, 1919. The question of correcting the exchanges received the attention of the leading financiers in the City.® However, some futile proposals were made, such as the organization of an All-Empire Bank, much resembling the abandoned Federal Reserve Foreign Exchange Bank in the United States.' i. Merchandise Shipments During the war the trade correctives were absent. As a bel- ligerent Great Britain was not in a position to check imports nor stimulate exports. After the war, however, the self-correctives again became operative. Imports decreased and exports increased. In the last normal year before the war, the excess of British imports was £133.9 million, in 191 8 it was £783.8 million. The latter was the high annual record of the war. In 1919 the excess of imports was only £669.3 million and in 1920 it had declined to £378.8 million. 'Commerce Reports, Feb. 2, 1930, p. 541. ° Suggestion of F. C. Goodenough, Chairman of the Barclay's Bank. Digitized by Microsoft® 412 INTERNATIONAL FINANCE AND ITS REORGANIZATION Trade Balance of Great Britain (in millions sterling) 10 Year Imports Exports, including foreign and colonial produce Escess of imports 1913 1918 1919 1920 768.7 1316.1 1631.9 1936.7 634.8 S3«-3 96*. 6 ISS7-9 133-9 783-8 669.3 378.8 The imports rose from 121. i per cent of exports in 1913, to 247.2 per cent in 1918, and declined to 169.5 'n 1919 and still further to 124.6 per cent in 1920. The self-corrective effect was noticeable particularly in the latter half of 1920. In January, 1920, the ratio of imports to exports was 140 per cent. In February, it was 157 per cent, in March, 135 per cent, in May, 119 per cent, and for the rest of the year the average monthly figure was about the same as in May, although in November the ratio of imports to exports had declined to 109 per cent Although improvement was apparent in the trade figures, it was not reflected in the exchange rates, because the exports were going to the financially weak countries of Europe. For example, the value of the excess of British exports to France, Belgium, Italy, Germany and minor states was astonishingly large. The table is given herewith: Excess of British Exports (in nuUions sterling) Country France Belgium Italy Germany 1920 (9 months) 81.8 20.7 SI. 3 14.8 X919 134.8. 56.3 18.8 33. a 1913 X7.x« 9.9* 6.5^ 87.5* • Excess of British imports. " Official returns of the British Board of Trade. Digitized by Microsoft® BSITISH FOREIGN EXCHANGE 413 ii. Gold Shipments The shipment of gold was an important corrective of the depreciat on of sterling during the war. (a) Amounts — In 1914 the gold exports amounted to £30.6 million. In 1915 the amount was £39.2 million. In 1916 it was £38.4 million. Upon the- entry of the United States into the war British exports of gold declined very greatly. Figures are unavailable, covering the period from April, 1917, through March, 1919, when the "peg" was released. From July to December, 1919, the exports of gold amounted to £14.6 million and during the year 1920, the amount was £92.6 million.*^ Most of the gold shipped before April, 1917, was consigned to the United States and lesser amounts to the neutrals of Europe. During 1919 and 1920 when the figures were again published, the exports were consigned to the United States, South American countries, British India and South Africa and the Straits Settlements. The total United States imports of gold since the beginning of the war were largely from the British Empire, as is shown in the table following. United States Imports of Gouj ^' (in million dollars) Fiscal Total From From Year United Kingdom Canada 1914 66. s 2.6 38.3 191S 171.6 2.0 iro.8 1916 494.0 118.0 267. s 1917 977.2 46.4 884.1 1918 124.4 0.0 103.0 1919 62.4 0.0 36.5 1920 iJo.S 64.4 39.7 (b) The Embargo- On April I, 19 19, an order in council was issued to prohibit the exportation of gold, coin and bullion and to give the govern- " Annual Statement of Trade of the United Kingdom, 1914-1918. Accounts Relating to Trade and Navigation, 1919 and 1930. "^Monthly Summary of Foreign Commerce, June, 1914-1920. Digitized by Microsoft® 414 INTERNATIONAL FINANCE AND ITS REORGANIZATION ment control over gold movements.*' A law to the same effect was passed on December 23, 1920. The reason for the gold embargo was the decontrol of the exchanges in March, 1919. To have permitted gold to flow freely then would have transferred the world's demand for gold from the United States to Great Britain, the great excess of imports of which would have drained its gold supply very quickly. Furthermore, the countries indebted to Great Britain on merchandise imports were not in a position to ship gold, and therefore Great Britain could not settle with her merchandise creditors in gold. The British gold policy therefore was dependent on the Continental gold policy,** However, after July, 1919, new gold received from the mines might be exported under license. Mine gold from South Africa was offered in London to the highest bidder, and was taken fre- quently by those countries in which the pound sterling was at a considerable discount. The exports of gold from Great Britain in the latter half of 1919 came from this source. This gold affected but little the settlement of trade balances. These gold exports, however, were only a very small fraction of the British excess of merchandise imports. For example in 1919 the net com- modity imports to Great Britain from the United. States was $1970 million, but the net excess of exports of gold to the United States from Great Britain was only $42 million. In 1920 the net excess of commodity imports from the United States to Great Britain was $1094 million, and the net excess of imports of gold from Great Britain was only $205 million. The excess of commodity imports into Great Britain in 1920 was £378,800,000, but the excess of exports of gold was only £43,500,000. South African gold was quoted in London in paper money at a premium over the gold parity, which was 8ss. per ounce. The premium represented the depreciation of the British note as truly as if gold and paper circulated side by side in domestic trade. For instance, on November 30, 1920, the demand rate for sterling in New York was $3.48, representing a depreciation of about 28.5 per cent. The gold price in London on the same day was 117s. " For a discussion of the order see the bullion letter of Samuel Montagu & Co., Apr. 3, 1919. "No figures on British gc"d exports are available prior to July, 1919. Neither trade returns nor any source of financial information furnished statistics of gold exports. The Montagu bullion letter resumed publication of gold shipments in the latter half of 1919. Digitized by Microsoft® BRITISH FOREIGN EXCHANGE 41$ id., which represented a depreciation of about 27.5 per cent from the gold parity of 85s. During the week ending January 15, 1 921, tliere was a violent rise of sterling rates in New York, and simul- taneously a precisely proportionate fall in the price of gold in London. The high and low gold quotations for the year 1920 were 127s. 4d. and I02s. 7d. and paper money was at 66.7 and 82.8 per cent of parity, respectively. The high and low foreign exchange quotations for the year 1920 were $4,012 and $3,195, or 82.8 and 65.7 per cent of parity, respectively. If gold flows internationally, the depreciation of foreign exchange and the pre- mium on gold represent the discount on paper money. On the other hand, if gold does not flow freely, as in the case of Continen- tal Europe, the depreciation of the exchanges does not correspond so closely to the depreciation of notes. iii. The Flow of Capital The most important corrective of depreciation of sterling was the flow of capital. British holdings of American securities were sold. European securities quoted on the London exchange were sold in New York. Private loans, both long-term and short-term, were placed by Great Britain in various markets, and finally United States government advances were negotiated. (a) The Resale of American Securities — Before the United States entered the war there was heavy liquidation of British holdings of American securities. A singular instance was the resale by British owners of an entire railroad in the United States, the New Orleans & Northeastern, at a price of $12,500,000. Messrs. J. P. Morgan & Company, acting as agents for the Southern Railway, concluded the arrangements, involving the transfer of about $6,000,000 in bonds and about $6,000,000 in stock. The proceeds were applied against the purchase of British government 6 per cent exchequer bonds due in 1920. I. The procedure of the dollar securities committee — In July, 1915, when sterling was depreciating, the British Treasury instructed the Bank of England to purchase American dollar securities in London and transmit them to New York for sale. In January, 1916, the Committee issued a selected list of 54 American securities, giving daily the New York cable quotation of the previous day as the purchase price. On the first day securi- Digitized by Microsoft® 4l6 INTERNATIONAX FINANCE AND ITS IlEORGANIZATION ties of a par value of over 2 million dollars were obtained. The list was extended, and by March 17, 1916, over 256 different issues were bought by the Bank of England from private holders. On March 24, 1916, the Treasury introduced the deposit scheme under which securities were loaned to the Treasury. But as the amounts of securities deposited seemed small, an additional income tax of 2s. in the pound was levied to compel the deposit of such securities as the Treasury was willing to purchase. On January 25, 191 7, an order in council empowered the Treasury to requisi- tion any securities that it might require for the purpose of strength- ening the financial position of the country, thus converting the scheme for mobilizing securities from a voluntary to a compulsory basis. If the Treasury acquired entire ownership, the value of the securities at the current market price was paid. If the Treasury desired only temporary use of the securities, interest and dividends accrued to the holders, plus an additional J^ per cent per annum, calculated on the nominal amount of die securities. There were stringent conditions attached to the granting of permission to sell abroad any holdings of foreign securities. On January 2, 1919, the prohibition on die sale of securities abroad without die permis- sion of tlie Dollar Securities Committee was removed. The pur- chase of securities was discontinued, except with regard to those subject to requisition or already on deposit and the purchase of these was discontinued on April 28, 1919. After March 31, 1919, the additional income tax of 2$. in the pound was discontinued, and the return of securities to their owners began on April i, 1919. z. Amounts mobilized during the "peg" — The total anMunt of securities mobilized was 31 12 million dollars, of which 1083 million dollars was purchased and 2029 million dollars was loaned. Of the total amount mobilized, the American securities were 40 per cent Of the total amount deposited on loan the American securities were only 18 per cent. Of the total amount purchased for resale, the American securities were 82 per cent. The American securities constituted most of those purchased for resale, because the New York market, in which the pound sterling had to be stabilized, was the best market for the liquidation of these securities. Most of the American securities mobilized were sold. Of the 1252 million dollars mobilized, 888 million dollars were sold up to March 31, 1919, and a large part of the remain* Digitized by Microsoft® BRITISH FOREIGN EXCHANGE 417 ing 364 million dollars were sold by January i, 1921. Of the Argentine bonds mobilized about 100 million dollars were sold, and the amount outstanding on October 30, 1920, was 1640 million dollars, most of which consisted of railway securities. For several reasons the Indian and Colonial securities were little affected by the mobilization scheme. Paish estimated that the total shrinkage in value of securities during the war including the period prior to mobilization amounted to 2260 million dollars. A check computation from the report of the Commissioners of Inland Revenue, showing the income received from foreign and colonial securities, indicates a shrinkage in value of foreign securities of about 2225 million dollars. The very close agreement, within ij^ per cent, may be fortuitous. At all events, the net loss in the value of British holdings was probably near 2 billion dollars. Both figures include the loss in market value, as well as sales of securities. Amotjnts of Doliar Securities Mobilized on March 31, 1919 " (in million dollars) Purchased Loaned Total Dollar bonds 680 241 197 304 877 S4S Dollar shares Total 921 33 SOI 137 1422 170 Deduct Canadian securities included. . . All securities, including Dutch, Scandina- vian and sterling bonds and registered stocks 888* 1083 71 35 82 364 2029 1 29 18 1252 3112 100 Percentages of securities purchased and loaned: All securities 100 Percentage of American secxmties to total securities AO *i8io diSerent securities. The Statist estimates looo million dollars resold up to Oct 30, 1920. t The Statist estimates that the maximum reached subsequent to the date of the report was ZZ92 million dollars. "^ Report of the Dollar Securities Committee, Nov. 20, 1917, submitted to the House of Commons, No. 212, also London Statist, Oct. 30, 1920. A review of the Dollar Securities Committee report is to be found in the London Economist, p. 1033, Dec. 6, 1919, and abstract of the report by A. M. Sakolski in the American Economic Review, June, 1920, p. 413, Digitized by Microsoft® 4l8 INTERNATIONAL FINANCE AND ITS REORGANIZATION 3. Sales after the release of the "peg" — ^The sale of American securities by British holders continued after the release of the "peg." For a time the sellers were required to provide an equivalent value in dollars, but on November 11, 1920, this restric- tion was removed, probably in view of the fact that the Anglo- French loan, maturing October 15, 1920, had been successfulUy met. Again, the amount of deposit securities held in August, 1920, was only 1337 million dollars, representing in part collateral for the then unexpired Anglo-French loan. Many of these were sub- sequently liquidated. The sale of British holdings of American securities affected not only those issued in dollars, but also those issued in pounds. From time to time sterling bonds of American railroads were sold privately at a price which took into account the depreciation of the pound. For example, in December, 19 19, a block of £20,000 of Pennsylvania Railroad Closed Consolidated Sterling 3j^'s was bought on the basis of $663 for a £200 bond. Normally, the holder of bonds issued in sterling would retain them in the expectation of an appreciation in exchange. It is doubtful whether large amounts of such bonds were sold in the United States. Furthermore, sterling bonds of foreign governments and cities listed on the London Stock Exchange were liquidated in New York in considerable quantities in 1920 and 1921. (b) Sales of European Securities — Another corrective of depreciation of sterling was the sale of internal bonds of the United Kingdom. These were bought and traded in extensively in the United States. In addition there were sold in New York several industrial securities which had an inter- national market, such as the shares of the Royal Dutch Company, the "Shell" Transport and Trading Co., Ltd., the DeBeers Mines. Ltd., and the Rand Mines, Ltd. These are discussed in the sec- tion on foreign exchange in the United States. Although the total amounts aggregated a considerable sum, only a very small fraction of the total securities outstanding were sold in New York. The control of the companies was firmly held in Europe. (c) Foreign Borrowing — Borrowing abroad was the chief means of balancing the excess of imports of Great Britain during the war, and thus partly cor- rected the depreciation of the pound sterling. Both short-term loans and long-term loans, the latter secured and unsecured, were Digitized by Microsoft® BRITISH FOREIGN EXCHANGE 419 sold in New York. In addition the British government borrow^ed of the United States government. I. Restriction on the exportation of capital — a. The method and effect — Early in the war, new issues of capital were controlled by the British government. The purpose was primarily to keep the supply of credit at home, and to direct it to purposes essential for the war. The effect on the distribution of the new issues was striking. In the three years before the war over 80 per cent of the total capital issues in Great Britain were for foreign purposes. The restriction on the issue of capital during the war resulted in a great shortage of capital for home uses, and after the war a larger per- centage of new capital was retained at home than before. In the year 1919, about 80 per cent of the total issue was retained for home purposes. The reasons are obvipus. During the period of the deprecia- tion of the pound sterling, lending abroad extensively would have aggravated the depreciation. Furthermore, the pound sterling, if loaned in countries in which it was at a discount, would not yield as profitably as an investment as at home, and finally sterling exchange might be restored to parity by an increase in production in Great Britain, for which purpose increased industrial facilities were required. British Capital Issues Distributed Geographically '' Calen- dar year For Domestic Purposes For Foreign Purposes Total' Issues * Million pounds Per cent of total issues Million pounds Per cent of total issues Million pounds Relative figures 1913 = 100 191 1 1912 1913 1914 191S 1916 1917 1918 1919 1920 28.3 47-1 44.6 40.7 8.3 8.9 8.8 40.3 187.6 331 14.7 22.7 18.2 20.4 10. 25.6 33-2 61.7 79.0 86.2 164.0 160.0 197. S 158.9 74.7 25.8 17.6 25.1 49-9 53° 85.3 77.3 81.8 79.6 90.0 74.4 66.8 38.3 21.0 13.8 192.3 207.1 242.1 199.6 83.0 34-7 26.4 6S.3 237. S 284.0 79 86 100 82 34 14 II 27 98 157 • Excluding British government loans. "London Joint City and Midland Bank monthly circular, January, 1921. For detailed analysis, see article. Capital Issues in 1920. Statist, Janu- ary 8, i9»i, p. so. Digitized by Microsoft® 420 INTERNATIONAL FINANCE AND ITS REORGANIZATION b. The removal of restrictions — ^The removal of the restrictions on the exportation of capital was accomplished in several stages. In January, 1919, holders of Colonial and Indian securities were permitted to sell ?hem abroad. In April, 1919, restrictions on the issue of capital for domestic purposes were removed, and in August, 19x9, the embargo on the exportation of capital was lifted. On January 7, 1919, the British Treasury announced that under the Defense of the Realm Act of January 24, I9i7i Colonial and Indian securities might be shipped abroad subject to the con- dition that the proceeds of such sales or of maturing securities collected abroad should be remitted to Great Britain and retained there. Further, restrictions, affecting securities in which any enemy interest was concerned, continued in force. In March, 19 19, the Chancellor of the Exchequer announced in Parliament that all issues by companies established in Great Britain would no longer require a Treasury license, if the issuing company certified that no part of the proceeds were to be applied for capital purposes outside the United Kingdom. Issues by British companies for capital purposes abroad were permitted only under license. Owing to the decontrol of the exchanges in March, 1919, it was important to limit such fluctuations as might result from the exportation of capital. On August 19, 1 919, the restrictions on the exportation of capital and the importation of securities were completely lifted by the Treasury, except in the case of securities held by or for an enemy during the war. That is, British investors were permitted to buy American securities, although they were hardly likely to do so in view of the adverse exchange rates. The restrictions were abandoned chiefly because the removal of the censorship made their enforcement impossible. On August 28, 1919, the Treasury announced the withdrawal of the following regulations : (i) "41 D. Defense of the Realm Regulation which prohibited remittances from United Kingdom by way of loan or for the purchase abroad of securities or property other than merchandise, or for the pur- chase of foreign currency as an investment or to be held with a view to appreciation in value. (2) Import Regulation (M.21), which prohibited the importation of bonds, shares, scrip or other documents of title. (3) Defense of the Realm Regulation 30 F par. 4 (6), which prohibited the purchase or sale of securities which had at any time since September 30, 1914, been in physical possession outside the United Kingdom." Digitized by Microsoft® BRITISH FOREIGN EXCHANGE 421 2. Long-term loans — Before the United States entered the war the private loans placed by Great Britain in this country amounted to $1050 million, consisting of one unsecured loan dated October i, 19 15, due October i, 1920, for $250 million; a secured loan for $250 million, dated September i, 1916, and due September I, 1918; a second secured loan of $300 million dated November I, 19 1 6, and due in parts November i, 1919 and 1920; and a third secured loan of $250 million dated February i, 191 7, and due in parts on February i, 191 8 and 191 9. On November i, 1919 a private British loan amounting to $250 million was placed in the United States, the first after the close of the war. It consisted of 3-year 5J^ per cent gold notes due in 1922, and lo-year Sj4 per cent gold bonds due in 1929. Both securities were convertible at the option of the holder into 5 per cent National War Bonds of the United Kingdom, sterling exchange being computed for purposes of conversion at the fixed rate of $4.30 to the pound. As the rate of exchange rose above $4.30 the holder would realize an increasing profit, and at exchange parity the seller of a National War Bond at 100 would obtain $113-19. The Anglo-French loan due on October 15, 1920,' was com- pletely paid off at maturity. On March 8, 1920, Mr. Chamberlain announced that the British government was buying Anglo-French bonds in the market at a considerable discount below par. The funds were obtained in part from the loan above referred to as well as from the further sale of British holdings of American securities. 3. United States government advances — From April 24, 1917, when the United States government advances were author- ized, to November 15, 1920, eight months after the Secretary of the Treasury announced that no further advances would be made, the total loans in favor of Great Britain amounted to $4277 million, of which $80 million had been repaid. Up to April 15, 1919, and May 15, 1919, interest was paid by Great Britain out of British funds in the United States, or from further credits of the United States. Interest subsequent to these two interest dates and up to October 15, 1920, and November 15, 1920, amounted to $104 million.^' "Annual Report Secretary of the Treasury, 1920, pp. 54 and 58. Digitized by Microsoft® 482 INTERNATIONAL FINANCE AND ITS REORGANIZATION 4. Treasury bills and short-term credits — In addition to the various forms of long-term borrowing, England relied upon treasury bills and short-term credits, which were placed in those countries in which she made heavy purchases. a. United States — ^The sterling and dollar treasury bills, floated by Great Britain in the United States, have already been referred to in the sections on British public finance and on the stabilization of exchange in the United States. (See pp. 361 and 377.) As early as 19 16 the British government attempted to float short- term bills in New York, but the Federal Reserve Board warned its member banks against "freezing" their funds in securities, which though short-term in name were either by contract or through force of circumstances long-term in character. Upon the entry of the United States into the war considerations of prudent banking were displaced by military necessity. After August i, 19 1 7, the British Treasury successfully issued dollar treasury bills in New York. The rate of interest varied from 5 to 6 per cent and the amount outstanding reached a maximum of about lOO million dollars in 1919.^' The continually maturing treasury bills proved to be a depressing influence on the exchange rate and there- fore the British government continually reduced the amount out- standing by means of gold shipments and the further sale in the United States of the mobilized dollar securities. On November 8, 1920, the amount of British government dollar treasury bills outstanding in the United States was officially reported by Consul General Skinner as $31,540,000. "On December 20, 1920, there were outstanding $18,220,000" and they were being further reduced according to J. P. Morgan & Company. In addition, twelve months' sterling bills, payable at option of the holder in dollars at $4,765, were outstanding in amounts of $28,590,000 on November 17, 1920. The amount had been much larger.^'* The "Consul General Skinner of London reported the maximum official figures of British dollar treasury bills in the United States as $98,005,000 on September 30, 1919. See Commerce Reports, Dec. as, 1920, p. 1253. According to J. P. Morgan & Company, "British government 90-day treasury bills were increased to a maximum of $91,055,000 on March 80, 1919. And from Aug. i, 1917 to Nov. 11, 1918 the maximum outstand- ing was $84,405,000," See also London cable to Journal of Commerce Nov. 12, 1920, giving National Debt Office figures of amounts of treasury bills outstanding in the United States, 18a House of Commons Debates, November 18, xpaa Digitized by Microsoft® BRITISH FOREIGN EXCHANGE 423 total aoiount of sterling exchange bought in New York by J. P. Morgan & Company for the account of the British government dur- ing the period of the "peg," from early 1917 to March, igig was close to $4,000 million. On several occasions the amounts pur- chased were as high as $20 million per day. b. Japan — In July, 1916, Japan supplied the British govern- ment with credits in the United States, amounting to $50 million, in exchange for one-year yen treasury bills issued in Japan and renewed in July, 191 7. In December, 19 16, a British loan, amount- ing to 100 million yen, was issued in Japan in order to provide the British Treasury with an equivalent dollar credit in the United States. In January, 1918, the British government received from Japan an additional dollar credit in the United States for $50 million, in return for which the British government gave Japan one-year British treasury bills amounting to 80 million yen and a credit in India of 30 million rupees. The reason for this twofold transaction was that Japan had dollars in America which Britain needed, to maintain exchange between New York and London, and instead of making the proceeds available in London the Japanese government provided the British government with 40 million dollars in New York. Then as Japan needed rupees in India to pay for an excess of imports. Great Britain opened a rupee credit in India in favor of Japan in return for which Japan gave the British Treasury additional credit of $10 million in New York." On February i, 1919, Great Britain refunded the $40 million of British one-year treasury bills in Japan. The rate was raised from 5^ to 6 per cent. c. Neutral Europe — Owing to the proximity of the neutrals of Europe to Germany and their dependence upon her for some indispensable commodities, the Allied governments had difficulty in raising credits in the neutral countries for the purpose of stabiliz- ing exchange.^^* After the armistice a financial convention between Spain and Great Britain was consummated whereby Spain agreed to lend Great Britain 75 million pesetas at 5 per cent. Great Britain in return agreed to permit the free importation of Spanish "London Economist, Jan. a6, 1918. "'See Hearings before the Committee on Banking and Currency on 8.3928, "A Bill to Establish a Federal Reserve Foreign Bank," op. cit. Digitized by Microsoft® 424 INTERNATIONAL FINANCE AND ITS REORGANIZATION oranges and the exportation to Spain of a minimum quantity of 150,000 tons of coal per month. The payment for coal was to be in sterling at 25.18 pesetas, or parity.^" A credit in Holland for 75 million florins was opened in favor of Great Britain, but only 50 million florins were taken up.*^ d. Argentina — In January, 1918, a grain convention was con- cluded between Argentina and both Great Britain and France. The governments of Great Britain and France agreed to buy in Argentina the surplus of wheat and other cereals up to 2,500,000 tons, to be exported before November i, igi8. The Argentine government on its part agreed to open a credit in favor of Great Britain and France up to $100 million.^^ Against these advances the Allied governments agreed to deposit notes for two years, bear- ing 5 per cent interest annually. The financing of the wheat exports from Argentina was done by the Banco de la Nacion. However, the Caja de Conversion was authorized to issue notes against its gold holdings if the Banco de la Nacion exhausted its resources. The loan was not paid at maturity and was extended. In part liquidation of this loan, Great Britain took over the $50 million loan of Argentina, due in the United States on May 15, 1920, and agreed to meet in London the charges on the Argentine foreign debt. At the same time the Argentine government was to pay the equivalent sum, at a fixed rate of exchange, to the Banco de la Nacion to reduce the British foreign debt.^* After the war, Great Britain, France and Italy negotiated for a loan in Argentina for 200 million gold pesos ($193 million) for the purchase of grain in Argentina. This was similar to the con- vention just cited, except that slightly different exchange rates were fixed. The credits were distributed as follows: 80 million pesos to Great Britain, a similar amount to France, and 40 million pesos to Italy. The period of the loan was to be two years and the rate 5 per cent. The proceeds were to be applied to the pur- chase of Argentina produce exclusively. The Banco de la Nacion was authorized to open a credit in favor of the government for *" Cable from Ambassador Willard, in Commerce Reports, Apr. i, 1919. "Amsterdam correspondence, London Economist, June 19, 1920. ^ Commerce Reports, Feb. 9, 1919. "From Tornquist, "Business Conditions in Argentina" reports Nos. 148 and 149 of May 31, and October 31, 1920. Digitized by Microsoft® BRITISH FOREIGN EXCEANGE 42$ 200 million pesos, and the Bank in turn was authorized to apply to the Caja de Conversion for currency notes up to the amounts of the credits used by the three European governments. As the credits were paid off, the Bank was to return to the Caja for can- cellation the notes issued under the credit. The Senate refused to ratify the convention hecause of the fear of the drain on the Caja de Conversion, and the desire to give Germany a similar advantage. The treaty as revised by Argentina was unsatisfactory to the Allies.^* 5. Preferential discount rate — Before the war the central banks of Europe were able to attract funds from foreign countries by raising the discount rates, thus creating a supply of bills. On November 15, 1915, the Bank of England initiated a preferential rate of 4j^ per cent on deposits by joint-stock banks, of money representing foreign balances on deposit with them. On these foreign balances the joint-stock banks had been paying a premium of I per cent and more over domestic; balances. The Bank of England had been paying more on joint-stock bank deposits repre- senting foreign balances than it was getting on its own loans, many of which were made at 3j^ per cent. As in pre-war times, the aim was to attract foreign funds to sustain the rate of exchange. In January, 191 9, the Bank of England reduced the rates on joint-stock balances representing French, Italian or Belgian funds, because the currencies of those countries were depreciated in London and the attracting of French, Italian and Belgian funds to London tended to aggravate this depreciation. On August 28, 1919, the Bank of England announced a reduction in its rate of interest on all foreign balances from 4j^ to 3 per cent, and the joint-stock banks made corresponding reductions. If American balances in London had been large, the reduction might have driven American money out of the London banks. But American balances were small, and the ruling had practically no effect on them. In fact the rate was reduced in recognition of the fact that the high rate was not effective. When exchange is upset and fluctuations are wide, slight dif- ferences in the annual rate of interest are not likely to attract ''London Economist, Oct. 11, 1919, et seq. The_ Review of the River Plate gives details providing for German participation in the agricultural credit. Digitized by Microsoft® 426 INTERNATIONAl FINANCE AND ITS REORGANIZATION funds. The possibility of gain or loss on exchange due to wide fluctuations is a far more important consideration than changes in the rate of interest of a fraction of i per cent. The pre-war mechanism of attracting funds by raising the interest rate was therefore operative only under conditions of fairly steady ex- changed^ iv. Other Correctives Just as inflation of the currency, the inability to balance the budget, and political and industrial unrest accounted for the decline in exchange, so the improvement of these factors corrected the exchanges. That a definite limit had been set on the fiduciary issue, that the national debt of Great Britain was being reduced and the industrial production gradually increased after December 31, 1919; all these factors accounted for the betterment of British exchange. As the Cunliffe Committee stated in its final report, "Increased production, cessation of government borrowing and decreased expenditure both by the government and by each in- dividual member of the nation, are the first essentials to recovery. These must be associated with the restoration of the pre-war methods of controlling the currency and credit system of the country for the purpose of reestablishing at an early date a free market for gold in London." D. The Invisible Balance of Trade The outlook for British exchange depended upon the invisible factors which constituted a very important part of the British trade balance. i. Foreign Investments The foreign investments of Great Britain rose from the equivalent of $2750 million in 1854 up to about $20,000 million in 1914. The estimates were made by Sir Robert Giffen, A. C. Bowley and F. W. Hirst, from the income tax returns. Sir George Paish's estimate in 1910 was based, in addition on the statements of several thousand British companies. " Commercial and Financial Chronicle, July 26, 1919 and Aug. 30, 1919. Digitized by Microsoft® BRITISH FOREIGN EXCHANGE BsmsH FoKEiGN Investments " (in millions sterling) 427 Date Amount Authority i8S4 SSo Bowley 187s 1,400 Bowley 1885 1,302 Gifien i88s 1,700 Bowley 1890 2,000 Bowley 189s 1,600 Hirst 190S 2,02s Hirst 1909 2.332 Bowley 1910 3.192 Paish 1914 4,200 Paish To obtain the 1914 figures, the average annual increase of foreign investments is used, which Hobson estimated at £130 mil- lion and Paish £152 million. Of the total foreign investments of about £3,200 million in 1910 about 53 per cent was invested in the Americas, 16 per cent in Asia, 14 per cent in Africa, 12 per cent in Australasia and 5 per cent in Europe. British investments in the colonies totaled £1,554 million and in foreign countries £1,638 million. Invest- ments in the United States were estimated at £688 million, in Argentina £270 million, and in Mexico £87 million. Invest- ments in British North America were estimated at £373 million, and approximately similar amounts in the British dominions and colonies in Asia, Africa and Australia. ii. War-Time Changes in Invisible Credits Before the war, in spite of the large excess of imports of Great Britain, the annual foreign investments of Great Britain increased, the pound sterling was not depreciated, and as a rule more gold was imported than exported. The adverse balance of trade was "Arthur H. Bowley, Annals of Foreign Trade in the 19th Century 1905 Edition, pp. 76-77. Report of the Commissioners of Inland Revenue, quoted by Sir George Paish in Journal of Royal Statistical Society, Sept., 1909. C. K. Hobson, The Export of Capital, London, 1914, p. izS. The London Economist, Jan. 23, 1886, p. 105-106. G. R. Porter, The Progress of the Nation, revised by F. W. Hirst, 1912 Edition, pp. 701-702. Journal of the Royal Statistical Society, Jan., 191T, pp. 177-186. Report of Federal Trade Commission on Cooperation in Export Trade. Washing- ton: Government Printing Office, Part I, pp. 66-72. Digitized by Microsoft® 428 INTERNATIONAL FINANCE AND ITS REORGANIZATION being met by invisible exports. In the annual returns of foreign trade of Great Britain imports are recorded as c.i.f. (including cost, insurance and freight) and the value of goods exported as f.o.b. (free on board) ; the value of imported goods include charges for insurance and shipping, which are due to British companies chiefly, but the value of exports does not include similar charges, which are due also chiefly to British companies. This method of reporting increases the apparent excess of imports, or reduces the invisible credit balance. In addition to shipping services and insurance, British bankers and discount houses had annual invisible credits due them. Again, tourists spent large sums traveling in Great Britain. (a) Investments — Sir George Paish estimated that in 1914 British foreign invest- ments amounted to £4000 million and that annual interest was £200 million. During the war £1000 million of British holdings of foreign securities were sold and the annual invisible credit was reduced by £50 million. Furthermore, Great Britain borrowed abroad £1400 million, and an annual invisible debit of £70 million was added. The net change therefore was a deduction of £120 million from the annual invisible credit, leaving an annual credit balance of £80 million. The loans to the Allies amounted to £i739 million, but of this about one-third was loaned to Russia and one- half, or £870 million, had already been written off as a poor debt. Ultimately, Great Britain expects to receive on the remaining £870 million about £44 million interest annually. For some time, how- ever, the interest has been deferred and the annual income from investments for 1920 was therefore estimated by the British Board of Trade at £100 million, as compared with a pre-war estimate of £200 million. (b) Shipping Earnings — Shipping earnings do not represent a net profit. From gross earnings deductions are made for wages paid to English seamen, supplies bought in England, and other expenditures, chiefly in England. However, gross earnings are credits in the international balance of trade to the same extent as British exports. The esti- mate of shipping earnings in 1903 was £90 million, according to Sir Robert Giffen, and £100 million in 1910, according to Sir Digitized by Microsoft® BSITISH FOREIGN EXCHANGE 429 George Paish. Sir F. W. Lewis at the annual meeting of Furness, Withy & Co., a large shipping company, estimated the total for 1919 at £350 million to £400 million. The increase over the pre-war figures was due to the increase in chartering rates, chiefly. For 1920 the British Board of Trade estimated that the shipping earnings would be £500 million, later reduced to £340 million. (c) Other Earnings — For 1903 Sir Robert Giffen estimated the earnings of mercan- tile houses, insurance companies and banks, doing business abroad at £25 million. Owing to inflation, income from these sources was estimated by the British Board of Trade to be £40 million. Sales of old ships to foreigners, expenditures of tourists, and family remittances abroad were estimated to be £10 million before the war and £iS million in 1919 and 1920. However, the items are omitted from the calculation below. (d) Recapitulation — A summary of pre-war and post-war debits and credits is given herewith : British Tkade Balance^' (in millions sterling) Source 1913 1919 1920 Invisible credit, estimated— Net income from investnients NpI" shinniTip inrome 200 130 30 So 400 40 120 340 40 Other services Total 360 134 S20 663 500 379 Trade debit, actual — Excess of merchandise imports 226 13 143* 121 42 * Net debit. "British Board of Trade Journal, Jan. 15, and Aug. la, igao, and Feb. 3, 1921, reprinted in Commerce Reports, Feb, 24, and Sept. 17, 1920, and Mar. 16, 1921. See also Edgar Crammond on British Finance During and After the War, Quarterly Review, July, 1918. Hartley Withers, The Digitized by Microsoft® 430 INTERNATIONAL FINANCE AND ITS REORGANIZATION The excess of imports of Great Britain declined in 1920. In 1919 there were large imports both on account of balances on war contracts and on account of restocking empty stores. But in 1920 imports were limited to essentials. In 1919 the price of commodi- ties was about twice as high as in 1913. Therefore while the value of imports in 1919 was twice as great as in 1913, the quantity was only four-fifths as great. As prices fall, the purchasing power of interest from foreign investments will rise and will balance a larger quantity of imports than under inflated war prices. As an offset, however, shipping earnings will probably dedine as wages and the price of chandlers' stores decline. As a result of the net loss of investment earnings of £100 million per annum, the pre-war invisible balance of £360 million will in future probably be £260 million. To balance the debits and credits of international trade the excess of commodity imports will have to be reduced. For none of the invisible credits can be increased as largely or as promptly as imports can be reduced. Interest on British foreign investments cannot be rapidly increased, nor can shipping earnings after the war increase, owing to the competition of Japan and the United States developed during the war. According to the British Board of Trade figures there was a credit in the 1920 British trade balance of about £121 million, and yet the pound sterling was at a heavy discount in New York. The explanation may be that the British Board of Trade estimates for shipping gearings are too large, a not improbable assumption, or else that England extended liberal credits to the Continent to stimulate her exports, and that her credits were "frozen," but she had to liquidate her debts to the United States. In general England's debtors, both on war loans and on merchandise, are the poor countries of Europe, and her creditors both on war loans and on merchandise are the relatively rich countries of the Americas and Asia. As the Cunliiife Committee stated, "The difficulties of the foreign exchanges' position are aggravated by the grant of long-term loans and credits to enable foreign states or their nationals to pay for exports from this country. Few of these loans and Business of Finance, E. P. Dutton & Co. London Bankers' Magazine, Sept., 1919. London Economist, Oct. 17, 1919. Review of Barclay's Bank, Feb., 1919 and Oct., 1919. C. K. Hobson, Tlie Measurement of the Balance of Trade, Economica, London, May, 1921, pp. 133-147, Digitized by Microsoft® BEITISH FOREIGN EXCHANGE 43 1 credits will be liquidated at an early date. The large payments which we have to make to America, North and South, for neces- sary imports of foodstuffs and raw materials from those countries make it essential that we, in our turn, should secure payment in cash for as large a proportion as possible of our exports, visible and invisible. We therefore recommend that preference should be given to exports to countries which are able to make payments in ordinary course of trade." Digitized by Microsoft® CHAPTER XI FRENCH FOREIGN EXCHANGE ^ A. Trade Balance i. Total Investments Before 1850 French foreign investments were negligible in amount. In the fifty years from 1870 French foreign investments grew to about fr, 40,000 million, as follows : French Foreign Investments ^ Year Amount, million francs Authority 1870 1880 1910 1914 12,000 15,000 40,000 40,000 Leon Say Leroy Beaulieu Walter Zollinger Louis Klotz The total pre-war investment of France yielded an invisible credit of about fr. 2,000 million per annum, enabling her to have an excess of imports and at the same time maintain her exchange at parity. ii. Classification by Countries The distribution of French investments abroad indicates the very striking fact that Russia was the principal outlet for French 'See also Le ProbUme des Changes chez les Belligirants, Rapport Gfn^rale, 1919, No. 6158. Budget report of the Chamber of Deputies. "C. K. Hobson, The Export of Capital, pp. 139, 141, 142 and 163. Walter Zollinger, Die Bilanz der Internationalen Wert Uebertragungen, p. 191a. Hanz Hengi.r, Die Kapitalsanlage der Franzosen in Wert- papieren, pp. 10, ii and 89. Federal Trade Commission report on Co- operation in American Export Trade, vol. 1, p. 71, Washington: Govern- ment Printing Office, 1916. 43a Digitized by Microsoft® FRENCH FOREIGN EXCHANGE 433 investments, with Austria-Hungary and Turkey following. An unofficial estimate of French holdings on which interest had not been paid since the beginning of the war, follows: Country Million francs Russia ii,ooo 4,000 3,000 600 Soo 700 Austria-Hungaty Turkey Bulgaria Servia » Total 19,800 About 50 per cent of the total investments of France were either in enemy countries, or in countries affected by revolution or stricken by war and therefore unremunerative during the period. The esti- mates of French pre-war investments in Russia vary. Edmond Thery set the figure at fr. i2,cxk) million. Another estimate, set the total at fr. 17,636 million, distributed as follows: Million francs State issues and municipal bonds guaranteed by the state. Industrial shares and debentures IS1268 2,368 Total. 17,636 Another estimate put the total Frenth holdings of Russian securities at fr. 19,000 million, distributed as follows: Million francs For the Russian Imperial Treasury Railroads and public works under govemm'ent control Commercial enterprises in private hands but with govern- ment guaranty 7000 9000 3000 An official estimate, given in reply to an interpellation in the French Senate, gave the French holdings of Russian government stock as fr. 13,897 million, and total holdings, including loans to cities and industries, as fr. 25,000 million.^ ' Journal Offidel, Senat Debats, Mar. 28, ipso. Digitized by Microsoft® 434 INTERNATIONAL FIVANCE AND ITS REOKCANIZATION The investments in Bulgaria were estimated at f r. 700 million, * and in Turkey at fr. 3385 million. iii. Foreign Loans and Borrowings During the War During the war France loaned fr. 8200 million to her allies. In addition she furnished war materials valued at fr. 6500 million." Advances on account of German indemnity payments for the recon- struction of the devastated areas amounted to over fr. 20,CXX> mil- lion, by the end of 1920, making a total of about fr. 34,700 million. The foreign loans of France were offset by foreign borrowings. The cash advances by the United States government up to Novem- ber 15, 1920, amounted to $2966 million and the sales on credit of surplus war supplies to France amounted to $400 million.' The advances by Great Britain up to March 31, 1920, amounted to £568 million.'^ In addition to the government debt France owed abroad on a fixed debt, a floating debt, and bank credits. The private borrowings of France in the United States included the loans of Bordeaux, Lyons, and Marseilles for $45 million, the loan of the City of Paris for $50 million, and the 1920 unsecured loan for $100 million. A loan for lOO million yen was out- standing in Japan. The floating debt included treasury bills sold in England, of which £10 million were outstanding on January I, 1920, $25.5 million of treasury bills outstanding in the United States, and 30 million yen of treasury bills outstanding in Japan. Bank credits totaling the equivalent at par of fr. 1400 million were outstanding, in Spain, Switzerland, Norway, Sweden, Holland, Argentina, England, and Uruguay. iv. The Post-War Position of France If the advances on account of the German indemnity are included among the war-time loans of France her war-time borrow- ' Estimate of Professor Athenase Jaranoff, University of Sofia, in the Bulletin Official du ComitS National d'Expansion Economique, quoted by Trade Commissioner E. G. Mears, Constantinople, Commerce Reports, Jan. 3, 1920. ° Address of M. Louis Klotz, to Chamber of Deputies, Oct. 22, 1919, and Nov. 7, 1919. •Report of the Secretary of the Treasury for the year 1920, pp. 54 and 66. 'Budget address of Austen Chamberlain, Chancellor of the £xichc!quer» Digitized by Microsoft® FRENCH FOREIGN EXCHANGE 435 ings are fully offset. However she borrowed in foreign currencies and the conversion in francs in spite of their depreciation was at parity. On the other hand, French loans to her allies and advances on account of the indemnity were in depreciated francs. The pre-war investments of France, according to M. Klotz, amounted to fr. 40,000 million. The total war borrowings (from the United States, Great Britain and other countries) were equiva- lent at parity to fr. 33,000 million. The total war loans (to Russia, Italy and Belgium and minor allies) amounted to fr. 13,- 500 million, leaving a balance against France of fr. 19,500 million, which deducted from the total pre-war investments, leaves a net credit of fr. 20,500 million. On the other hand, the advances for reconstruction work in the devasted areas, which are to be refunded out of the German indemnity payments, amount to over fr. 20,000 million. But France is indebted to financially strong countries and is the creditor of financially weak ones. To consider her debits and credits as equally good risks is unjustified. The extent of the invisible balance of France depends upon many uncertain factors, such as the cancellation of the loans by Great Britain and the United States, the repudiation of Russia's debt to France, the ability of Germany to pay the indemnity and the cooperation of the debtors of France. B. The Causes of Depreciation The quotation of the French franc has been discussed at length in the section on foreign exchange in the United States. After the release of the "peg" franc exchange declined fairly continuously until April, 1920, recovered slightly up to October, 1920, and declined practically continuously thereafter, throughout the rest of the year.^ i. Commercial Causes The increase of the excess of imports was the chief cause of the depreciation of the franc. Before the war the excess of imports of merchandise was about fr. 1500 million. This was more than 'Liesse, Andre, La Hausse des Changes, Economiste Frangais, Feb. 7, 1920, pp. 161-4. Decamps, Le Credit International et la Crise du Change. Discussions de la Societe d' Economie Politique, Apr. 6, 192a EcQBomiste Franjais, Apr. 24, 1920. Digitized by Microsoft® 436 INTERNATIONAX FINANCE AND ITS REORGANIZATION balanced by the income of about fr. 2,000 million from investments, by earnings of the French mercantile marine, and by the very substantial expenditures of foreigners, resident, studying or tour- ing in France. During the war all these three sources of invisible credits were greatly reduced. Worse, the excess of imports increased enormously, reaching the high figure of fr. 24,000 million in 1919. Foreign Teade of France' (in million francs) Excess of Imports Imports Exports Ratio of Date Relative exports to imports. Amount figures, 1913 = 100 Per cent 1907 6,223 5.597 62s 41 90.1 1913 8,422 6,880 1,542 roo 81.7 1914 6,402 4,869 I.S33 99 76.0 191S 11,036 3.937 7.099 460 34.6 1916 20,640 6,215 14,425 935 30.1 1917 27.SS4 6,013 21,541 1395 21.9 1918 22,301 4,722 17,579 1140 21.3 1919 3S.799 11,879 23,920 1550 33-2 1920* 35.405 22,435 12,970 840 63.3 * Tentative. ii. Financial Causes An important financial factor in the depredation of French exchange was the loss of income from French capital, invested in the enemy countries, Austria-Hungary, Bulgaria, and Turkey, and in Bolshevik Russia. In addition loans were made during the war, to the weak countries allied with France: Italy, Servia, and Rumania, and after the war France made large loans to support her military policy in Poland. On December 29, 1920, a credit of fr. 400 million was voted by the Chamber of Deputies for Poland at the request of M. Raiberti, the Minister of War. On the other hand, France became indebted to financially strong countries, the United States and Great Britain. At the time they were made these loans strengthened French exchange, but upon their maturity 'Documents Statistiques sur le Commerce de la France, 1913, 19x9. Digitized by Microsoft® , FRENCH FOREIGN EXCHANGE 437 greatly depressed it. The French foreign debt on December 31, 1919, was fr. 33,661, or 15.6 per cent of the total French debt of fr. 215,399 million. iii. Fiscal and Currency Factors The depredation of the franc was in no small measure due to the inflation of the currency. The French budget did not balance and the Bank of France had to issue notes to the state against short-term treasury bills. In 1913 the French budget was fr. 4700 million, in 1920 the budget amounted to fr. 47,900 million. True, the ordinary expenses amounted to only fr. 21,700 million, but the extraordinary expenses amounted to fr. 5400 million and the special expenses, "recoverable from Germany under the Treaty of Peace," amounted to fr. 20,700. The service of the debt in 1920 was nine times as great as in 191 3. The ordinary budget was five times as great as in 191 3. These figures indicate the cause of the lack of confidence in the French financial administration, and of the depreciation of her exchange. As a result of the increase in the budget, and the inability to raise adequate revenue by taxation, the note issues of France increased continually throughout the war. At the end of 19 13 the notes outstanding amounted to fr. 5714 million, at the end of 1918, the amount was fr. 30,250 million, and on November 18, 1920, it was fr. 39,256 million. Since the ex- change rate is a measure of the probability of the redemption of paper in gold, a sevenfold increase in the volume of paper money could not fail to cause a heavy depreciation of French exchange. C. The Effects of Depreciation i. Commercial Effects The effect of the depreciation of exchange was the same as in the other countries of Europe. Exports were stimulated, and imports of non-essentials were checked. The imports of essential goods, such as food and reconstruction materials rose as exchange fell, increased the cost of living and the cost of rehabilitation of the devasted areas, and delayed the return to normal conditions. Finally, the depreciation of the franc resulted in barter and the elimination of exchange transactions. During the year 1920 French exports increased steadily each Digitized by Microsoft® 438 INTERNATIONAL FINANCE AND ITS REORGANIZATION month practically in the same ratio as the rate of exchange depre- ciated — on the other hand, imports were fairly steady. An analysis of the imports for the years 1919 and 1920 shows a decline in the importation of foods in 1920 and an increase in the importation of raw materials. Foreign Trade or Feance by Months foe 1920 '^ (in million francs) Month Imports Exports Ratio of exports to imports. Per cent 1913, average 1919, average 1920: January. . . February. . March .... April May June August September. October. . . 702 2981 2002 2642 3123 2888 2387 2589 2800 2628 2S9S 573 990 722 1324 1338 1377 1210 1809 2399 2152 2333 81.7 33-2 36.1 SO- 1 42.8 47-6 SO- 7 69.8 8S-7 82.0 90.0 In the first two months of 1921 the trade balance was reversed and the excess of exports amounted to fr. 185 million. The corrective effect of depreciated exchange is shown, though less strikingly in a comparison by years. Foreign Trade op France •' (in million francs) Year Imports Exports Ratio exports to imports. Per cent Excess of imports Relative figures, 1913=100 1913 1918 1919 1920* 8,421 22,301 3S>799 3S.40S 6,880 4,723 11,879 22>43S 81.7 21. 2 33-2 633 i>54i I7>S79 23,920 12,970 100 1140 840 * Tentative. '^ Documents Statistiques sur le Commerce de la France. "From official returns. Digitized by Microsoft® FRENCH FOREIGN EXCHANGE 439 The stimulation of French exports frightened the Swiss mer- chants, who in January, 1921, petitioned their government to restrict the imports from countries with depreciated exchange. Owing to the high value of the Swiss franc in France and in other neighboring financially exhausted countries, trade by means of bills of exchange between France and Switzerland was checked and barter became quite common. Barter arrangements were developed between the chambers of commerce of Switzerland and of other countries. ii. Financial Effects (a) The Breakdown of the Latin Monetary Union — As a result of the depreciation of French exchange the Latin Monetary Union brolce down. Its silver coins, which had been interchangeable in France, Italy and Belgium, were smuggled into Switzerland where the franc had a higher purchasing power than in France. In spite of the fact that Switzerland prohibited their importation, and that the other countries in the Union prohibited their exportation, more than half of the total 5-franc pieces issued by all the members of the Union came to be held in Switzerland. In October, 1920, French silver coins of 2 francs or less were withdrawn from circulation in Switzerland, and by April, 1921, all French, Belgian and Italian 5-franc pieces were withdrawn from circulation. (The effect of the depreciation of the French franc on the Latin Monetary Union was treated more fully in the section on French credit and currency.) (b) The Effect on Foreign Loans and Borrowing — Repayments on the credit opened in Spain in favor of France in 1 91 8 began in March, 1920, at the rate of 35 million pesetas per month. Although the loan amounted to 420 million pesetas, or an equal amount of francs at gold parity, at the depreciated ex- change the repayment required fr. 1000 million. At the time of the loan, in February, 191 8, the franc was equivalent to 70 per cent of parity in Spain, and to only 38 per cent in April, 1920. Corresponding to the increased number of francs needed to repay her creditors abroad, some of the debtors of France need less of their currency to repay her. France had a loan outstanding in Haiti, amounting to fr. 75 million, and in view of the depre- Digitized by Microsoft® 440 INTERNATIONAt FINANCE AND ITS REORGANIZATION elation of exchange — the franc was quoted at about one-third of its gold parity — Haiti negotiated for its repayment, in order to make a profit of almost $iO million." The invisible balance of France was upset. Before the war the purchasing power of the income from foreign investments was suflSciently large to pay for the French excess of imports. As the franc depreciated, the purchasing power of the invisible credits became grossly inadequate. Deflation in France and the appre- ciation of the franc will hasten the return of an equilibrium between visible and invisible balances. D. Correctives^"' The correctives of depreciation were stated to be a decrease of the excess of imports, gold shipments, and the flow of capital. The chief corrective of depreciation of the franc during the war con- sisted of loans by both Great Britain and the United States to their co-belligerent. It was an evidence of cooperation among the Allies that French exchange did not sink further during the war. In 1917 the Minister of Finance appointed a committee known as the Commission des Changes, which included representatives of the Ministry of Finance, the Ministry of Trade, and the Bank of France, whose function was to study the financial consequences of depredated exchange and to propose measures to correct them.** i. Commercial Correctives — The self-corrective character of depreciation of exchange has been explained elsewhere in this book. In addition, the French government adopted the policy of deliberately restricting imports and stimulating exports. It issued a list of luxury articles, the importation of which was forbidden. Goods intended for reex- " Washington dispatch. New York Times, Oct. 28, 19*0. Journal of Commerce, Oct. 30, 1920. "' Liesse, Andri, La Question des Changes Etrangers, Remides Empii- iques et Remddes Normaux. Economiste Fran^ais, Oct. 11, 1919, pp. 449-511 • "On March 21, 1919, an interministerial committee was created, to control _ exports and imports and to investigate cases and make recom- mendations, when the embargoes require modification. Journal Officiel, March ai, 1919. Economiste Franfais, March 29, 1919, p. 395. ques et Remides Normaux. Economiste Fran^ais, Oct. xi, 1919, pp. 449-51. Digitized by Microsoft® rSENCH FOREIGN EXCHANGE 441 portation were exempted." The statesmen of France urged the purchase of goods in countries whose exchange rate was more depreciated than the franc and the restriction of purchases in Great Britain and the United States. ii. Gold Shipments Exports of gold were not used to any extent to correct the exchanges. The 1918 report of the Bank of France states that fr. 2037 million of gold was held abroad, of which fr. 1955 million was in England as security for loans by the British Ex- chequer and by the Bank of England. This gold was to be returned to France upon the repayment of the loans. France pursued a policy of husbanding rather than using her gold supplies. Except during the year 191S, the trade returns show net imports of gold, in the three classes, coin, bullion, and leaf and mineral gold. Imports and Expoets op Gold " (in million francs) Yew Imports Exports Net imports 1913 593 -4 7S-2 Si8.2 1914 849.0 72.2 776.8 1915 38.6 117.9 79-3* 1916 61.8 2-7 59. 1 1917 7S-4 31 72.3 1918 13.8 1.2 12.6 I9i9t IS-2 0-3 14.8 * Six months. t Net exports. Upon the entry of the United States into the war, the exports of gold practically ceased. Up to that time gold was shipped to the United States, either directly or through Great Britain, in order to create an easy money market there and to facilitate "Cablegram to State Department from American Embassy at Paris. Washington, May 3, rgao. See also Paper No. XI, Exchange Control, Brussels Financial Conference, p. 115. Similar laws were passed May 6, ni6 Mar. 22, 1917, Jan. 20, 1919, and Dec. 30, 1919. See Journal Officiel. *° Tableau General du Commerce et de la Navigation, 1913-1918, and monthly returns for 1919. Digitized by Microsoft® 442 INTERNATIONAL FINANCE AND ITS EEORGANIZATION borrowing by the French government. Except in 1915 the exports of gold were more than offset by purchases of gold abroad. The total increase in the gold holdings of the Bank of France during the war of about fr. 2400 million were obtained from domestic hoards.^* United States Imports of Gold " (in million dollars) Fiscal year Total imports Imports from France 1914 66. s 1.2 191S 171. 6 n.6 1916 494.0 0.0 1917 977.2 0.0 1918 124.4 0.0 1919 62.4 0.0 1920 ISO'S 0.7 iii. The Flow of Capital (a) Restrictions on the Export of Capital — On August I, 191 7, a law was passed requiring that a register of foreign exchange transactions be kept by all persons that col- lected, bought, sold, negotiated or discounted foreign currency or bills, coupons, shares or bonds, the amount or proceeds of which were payable abroad in foreign money, or after negotiation abroad were held at the disposal of foreigners. Dealers were obliged to enter in the register the nationality and domicile of all persons transacting any foreign exchange business. The transactions in- cluded orders given in France for the sale abroad of francs or bills in francs, checks issued in France and presented for payment after having been negotiated abroad, checks drawn on France or payments in francs on foreign orders for more than fr. lo.cxx).*' The exportation of capital was prohibited by a law of April 3, 1918. Residents of France were forbidden to send out of the country for the purpose of sale any securities which would result not in a supply of francs but in a supply of foreign currency, to be used in violation of the existing laws. Residents of France were "Report of the Bank of France, 1918. "June Monthly Summary of Foreign Commerce, 1914 to 1910, "Decree of Sept. 4, 1917. Digitized by Microsoft® FRKNCH FOBEIGN EXCHANGE 443 likewise prohibited from subscribing abroad to new issues, or from making loans to persons outside of France, or from purchasing any securities, property or goods if such a purchase resulted in a transfer of funds from France. The importation into France of all securities representing an interest in a property or a mortgage was prohibited. The Commission des Changes provided for the administration of the laws concerning foreign ecchange.*' (b) Sale of Securities — Early in the war France liquidated some of her securities in London, such as the Brazilians, and the French international favorites, Rio Tintos, Royal Dutch, "Shell," and de Beers.^" After the war the depreciation of the franc stimulated the sale in neutral countries of French holdings of foreign securities. A steady stream of Swiss securities was shipped from France during the latter part of 19 19 to such an extent as to disorganize the Swiss stock market. For example, prime 3j^-per cent Swiss railway bonds on some days declined as much as 3 per cent. The securities which the French investors refused to surrender to the government to mobilize during the war were now sold in great quantities.*'- Yet the total sale of French holdings of foreign securities have not been very large, less than fr. 600 million according to one authority.** (c) Private Borrowing Abroad — I. Mobilization of securities — In the early part of 1916, M. Ribot, the Minister of Finance, requested the British authorities to permit dealings in French holdings of foreign securities on the London Stock Exchange. The French government called on the French holders of securities negotiable in London to turn them over for sale, in order to supply the state with foreign funds, in exchange for which the state made payment in treasury bonds. "Paper No. XI, Brussels Financial Conferences, ibid. Also Journal Officiel, Apr. 4, 1918, Commerce Reports, Apr. 16, 1918; and Apr. 29, 1918. London Economist, Feb. 15, 1919, p. 215. Information, Paris, Jan. I, 1920. " London Economist, Mar. 25, 1916 and May 27, 1916. " Frankfurter Zeitung, Dec. 10, 1919. '^ Report of M. Descamps, head of the Securities Department of the Bank of France, at the October meeting of the Soci£t£| Fran;ais d'Economie Politique, Nov., 1920. Digitized by Microsoft® 444 INTERNATIONAl FINANCE AND ITS REORGANIZATION The Bank of France arranged the transactions and devoted the proceeds to the payment of French debts in England. Owing to the limited capacity of absorption of the British market and to other difficulties this plan was not very successful, and arrangements were devised for mobilizing French holdings of foreign securities. Later, in 1916, M. Ribot galled for the deposit or surrender of neutral, including American, securities. These mobilized securities were used as collateral for loans placed in the United States. The securities listed included Dutch, Swiss, Scandinavian, Spanish, Egyptian, Argentine, Brazilian and Uruguayan securities. The French Treasury paid 25 per cent in addition to the net annual return of securities deposited with it and in the event of their sale, the owners were paid the highest market quotation during the preceding quarter.'^ By the end of December, 191 7, the Bank of France reported that the total securities mobilized amounted to fr. 640 million, consisting of over 774,cx)o securities. 2. Treasury bills and credits opened — The grand total foreign debt of France on January i, 1920, amounted to fr. 62,370 million, counting 10.75 francs to the dollar, or about 30,200 million gold francs. Of the total foreign floating debt 88.1 per cent was in treasury bills sold abroad and H.9 per cent in bank credits. a. In Great Britain — On April 14, 1916, the French and British governments entered into an agreement to stabilize French foreign exchange. Under the terms of this agreement gold was exported by the Bank of France to the Bank of England, and Great Britain granted credits, both unsecured and secured by gold and neutral stocks and bonds. Of the total French short-term foreign credits Great Britain extended the largest part. The English Treasury and the Bank of England also held deposits of French treasury bills against which British credits wer« opened. These two items combined constituted over 85 per cent of the total French foreign floating debt. After the release of the "peg" and the elimination of the support of the British Treasury and of the Bank of England, French treasury bills were sold abroad to correct French exchange. "Economiste Frangais, Feb. 9, May 13, 19x6; Journal Offidel, May 5, >9i6. London Economist, June to, 1916. Boutbeau, Marcel, La Bourse des Valeurs de Paris Pendant la Guerre, Paris, 1921. Part III, Digitized by Microsoft® FRENCH roSEIGN EXCHANGE 445 b. In the United States — During the war a number of French corporations opened credits with American bankers in order to finance exports to France. These credits were secured by neutral bonds as collateral and ran for three months with the option of five renewals. In February, 1916, the munitions works, Schneider- Creusot, placed a short-term loan of fr. 150 million through a syndicate of bankers in the United States. The French private banks and bankers cooperated in the task. Foreign Floating Debt of France, January i, 1920 (in million francs) Items Amount Percent of total Tteasuiy bills: i>eposited in the English treasvuy Deposited in the Bai& of England Sold in England Total in Great Britain Sold in the United States Sold in Japan , Total treasury bills Bank credits: Spain Uruguay Switzerland Argentina Holland England Norway Sweden Total foreign bank credits Total floating foreign debt Total fixed foreign debt Total foreign debt Total domestic and foreign debt i7,SS9 2.654 409 62,370 238,474 73-6 II. o 1.7 20,622 86.3 274 158 I.Z 0.7 21*054 88.x t,2ai 429 281 261 Z.8 1.2 x.x 221 0.9 170 139 116 0.6 o.S 2,838 II. 9 23,892 lOO.O 38,478 Before the United States entered the war, French treasury bills in francs were sold in the New York market. However, the Digitized by Microsoft® , 44