Chapter XXXII (1)

THE EARLY EVENTS OF THE EUROPEAN WAR IN RELATION TO MONEY BANKING AND FINANCE

AMERICAN FINANCE AND THE EUROPEAN WAR

[313]During the half-century that has elapsed since the Civil War, there has probably been no period of six months within which there have occurred transformations of so far-reaching a nature in American banking and finance as during the half-year between July 1, 1914, and January 1, 1915. It will be long before the full meaning and significance of these events are thoroughly understood; for what has been done cannot be finally interpreted until facts which have not yet been ascertained have developed their consequences. On the other hand, it would be impossible to forecast the ultimate effect of the European war should any one of certain tendencies which are still at least possible be fully carried out. What has already taken place, however, comprises a range of events full of important lessons and significant for the light they throw upon the methods to be employed in the near future in the management of industrial and commercial enterprises. This experience has been particularly rich in its bearing upon the relationship between banking and finance in the strict sense of the terms on the one hand, and the future of commerce and industry in general on the other. Though it be true that only hasty thinkers will endeavor to draw final conclusions from what has thus far occurred, it is, nevertheless, also true that much can be learned from the mere marshaling of recent events in their relation one to another.

I

Upon the outbreak of the European war, it was at once evident to all that very striking changes would result in every department of business life. There was, of course, at the outset no knowledge of the strategy or probable methods to be employed by any of the belligerents, and the general attitude of the business community was based upon the assumption that commerce would, for a time at least, become nearly impossible. As a corollary to that assumption, there prevailed the belief in many circles that American indebtedness to foreign countries would have to be liquidated in cash, and that this process would result in draining away from the United States a corresponding amount of gold. It was natural, therefore, that the first phenomenon of the war should be the suspension of dealings which it was believed would promote this gold movement, or would cause more serious trouble in any direction than would otherwise be inevitable. The closing of the principal stock exchanges of the country almost immediately upon the definite announcement that war was unavoidable was thus dictated by two considerations: (1) the belief that prices for stocks and other securities would be reduced to a point so low as to bring about the repurchase of the securities by Americans, who would then be obliged to pay for them in gold; (2) the belief that, in consequence of this reduction of prices, many bank loans based upon securities would have to be "called," thereby bringing about failures and incidentally assisting in the movement of specie out of the country.

In the case of the cotton exchanges, it was at once perceived that the cotton crop, which is so largely produced for export, could not now move abroad with any degree of facility, and that the demand for cotton would undoubtedly be slack. The very fact of the war, therefore, implied heavy reductions in the price of cotton, and the closing of the cotton exchanges was a measure of self-preservation on the part of the operators, who decided to protect themselves against the inevitable failures which would result from the fulfilment of existing contracts at very low prices. To close the exchanges would result in gaining time, and would, therefore, enable operators to meet their maturing obligations, besides perhaps affording an opportunity for actual recovery in cotton prices. This very fact, however, of the closing of the exchanges and the consequent removal of any other established method of determining prices for standard securities and for a staple like cotton involved most profound and far-reaching effects. The exchanges had closed in previous years, but never for the reasons which now controlled them. That they should close because of the fear of failure and the loss of gold implied a serious danger of disaster which appealed powerfully to the public mind, and which presented a problem that could not be explained away. The fact that, coincident with this closing of the exchanges, international trade was practically suspended for several days, and was seriously interrupted for several weeks, until British vessels assumed virtual control of the North Atlantic, tended greatly to increase the public anxiety. It formed, apparently, good ground for the suspension of business operations and for the non-fulfilment of contracts, even when the very difficult conditions did not themselves compel a recourse to such methods. The fact that foreign countries had adopted legislation deferring the date when debts need be paid or contracts fulfilled, although not paralleled here, produced a sympathetic influence upon business in the United States, which practically resulted in the partial or tentative adoption of a somewhat similar relaxation of commercial requirements in many industries and branches of trade.

It is notable that the Produce Exchange of New York and the other grain exchanges of the country continued in operation and did an enormous business in spite of the prevailing conditions. This was due to the fact that grain of all kinds, provisions, and every sort of food-stuff were, for the time being, subject to a very rapid upward movement. It was early perceived that a long continuance of the war would bring about a steady advance in the prices of all food products, the markets for which are not dependent upon temporary fluctuations for support, but are subject to far-reaching and semi-permanent influences. The fact that these exchanges continued open while those whose staples were subject to decline closed so speedily, naturally produced its own effect upon the public mind. Many who had thought the exchanges invariably faithful registers of price fluctuations were now reluctantly obliged to confess that this could not be the case, since those exchanges where prices were rising continued to operate without interruption, while those where prices were falling were obliged to suspend business. From one point of view, undoubtedly, the closing of the stock and cotton exchanges tended still further to deepen the attitude of dissatisfaction with these institutions that had been prevalent for some years among the American public. On the other hand, however, as time went on, it became clear that the exchanges of the country and the service they performed when in operation were being appreciated as never before by the conservative popular mind of the nation. With the exchanges closed it was seen that the lack of a regular and established market subject to natural conditions meant suffering and inability to secure the advantage of free competition in the establishment of the price of products. This view was once more emphasized when, later on, the cotton exchanges reopened; for it was then seen that the effect of trading upon the exchanges was to advance the price of the staple rather than to lower it, a view the precise reverse of that which had been originally prevalent for a long time past. Both in the psychological, as well as in the actual, effect of these closings, and in the influence the episode exerted upon public opinion, the suspension of the exchanges throughout the United States must be regarded as a fact of first-rate importance in the financial history of the United States during the European war.

II

Even without the suspension of certain classes of trading throughout the country, partially due as it was to the frenzied demand of European holders of American investments for money, the strain thrown upon our banks as a result of the great change in conditions would have been enormous. The closing of the exchanges, as already seen, had relieved matters to some extent by enabling the banks to avoid the calling of loans, and thereby to avoid the necessity of forcing customers into liquidation, with the resultant disastrous effect upon themselves. But on the other hand, the suspension of operations and the corresponding loss by the public would, it was felt, tend to the hoarding of legal-tender money. In order to meet this situation, the banks in many of the large financial centres sought to limit specie payments, taking out emergency currency and clearing-house certificates for the purpose of meeting their indebtedness to the public and to one another.... A phase of this phenomenon was seen in the tremendous rise in foreign exchange rates, the rates becoming practically prohibitive and thereby causing what amounted to a suspension of financial relationship between the United States and foreign countries, particularly Great Britain.

III

It was early understood that the real difficulty and danger in the international situation did not lie in the superficial symptoms of trouble, but were found much deeper, being directly due to the fact that international business had been practically suspended as the result of the war. This was a factor of prime and material importance in the whole situation, because the maintenance of established relations between the United States and foreign countries was directly dependent upon the regular exportation of goods. As was customary during the summer months, there had been large expenditures by American tourists in Europe; and we had become indebted to other countries, particularly Great Britain, for material sums in excess of what we were currently able to liquidate. This was on the assumption, as usual, that such indebtedness would be liquidated through the shipment of agricultural products, particularly of cotton, the country's principal cash crop. The breakdown of trade with Europe through the inability of vessels to run regularly at the outset of the war, and through the reduction of buying power, due to the interruption of all regular industrial, commercial, and financial operations, meant that in the absence of some restoration of the normal course of business it would be necessary to find other means of liquidating our obligations to foreign countries. The first phase of the difficulty was met by investigating the extent of international indebtedness, which, in the absence of other means of payment, would necessitate the draining-away of gold from the United States. Such an investigation was undertaken by the Federal Reserve Board, which, by sending out questions to the principal international bankers of the country, succeeded in forming a more or less trustworthy estimate of the indebtedness on current accounts, these being, of course, of varying maturities extending over several months. The problem thus raised was how to provide for liquidating the debts without losing so much of the underlying gold supply as to impair the convertibility of American securities, and therewith general confidence in American ability to meet obligations. The two chief proposals put forward for bridging over the period of difficulty were the establishment of a joint gold fund by the bankers of the country, and the undertaking of negotiations with Great Britain whereby some relaxation of foreign demands on the United States might be arranged for. These two phases of policy may best be cursorily sketched at this point.

Since the new banks had not yet been established and could not be put into operation for some weeks, it was deemed desirable to furnish a makeshift substitute for the co-operative effort which would have been available for the relief of the situation had the banks been in existence. It was therefore determined to suggest to a number of representative bankers the establishment of a joint gold fund to be used in providing exchange on Great Britain, and to have this joint fund developed at the earliest possible moment. A letter was consequently sent out to the presidents of clearing-house associations throughout the country, under date of September 21, in which request was made for subscriptions to a fund intended to aggregate about one hundred million dollars. This letter had previously been considered and approved at meetings of representative bankers summoned to meet in Washington on September 4 and 19 respectively, and was, therefore, issued with their moral support. The answer to this invitation was prompt and effective, a total of over one hundred and eight million dollars being subscribed and rendered available.

It was almost immediately evident that the operation of this fund was proving decidedly beneficial notwithstanding that only a comparatively small percentage of the amount subscribed was asked for, and that a still smaller percentage was actually used to furnish a basis for gold shipments. Nevertheless, it seemed, during the ten days immediately following the completion of the subscriptions, as if there might be need for still further relief to the situation. Some of those who were closely connected with the administration of the gold exchange fund brought the subject to the attention of the Secretary of the Treasury and he extended an invitation to the British Government to send representatives to this country mainly for the purpose of considering the possibility of further adjustment, in the event that the United States did not succeed in liquidating its indebtedness to Great Britain by the natural movement of commodities within a reasonably early period. The British Government designated Sir George Paish and Mr. B. P. Blackett, who came to the United States and on October 23 held a conference with the Federal Reserve Board. Subsequently another conference, attended by a number of representative bankers, was also held and the situation was discussed in very great detail. Meantime the establishment of a better understanding with reference to commodities to be considered as contraband and the more effective policing of the North Atlantic rendered possible the restoration of trade with European nations, and the development of the export trade proceeded with a speed which showed that current obligations of the United States to Great Britain and other countries would be liquidated at an early date without any necessity for further interference. By the time the reserve banks were ready to open [November 16], exchange sales on London had fallen to normal, and there was, therefore, no danger that when opened the reserve banks might, as was for a time feared by some, find their gold rapidly drawn away from them in order to meet the requirements of the gold export movement.

In another way it was deemed desirable that the Federal Reserve Board should help to facilitate the restoration of customary conditions in the financial market. Almost immediately after the outbreak of war it was seen that, unless hostilities should terminate within a very much shorter period than anyone thought likely, serious injury would be inflicted upon the cotton-producing states. As is well known, the cotton crop is largely grown for export, about two-thirds of the total production of the United States being annually sold abroad. It happened that an unusually large crop had been planted and was approaching maturity at the moment of the outbreak of the war. This would in any event have depressed prices of cotton, even under ordinary conditions. The almost immediate closing of the cotton exchanges of the country was, however, precipitated by reason of the interruption to the movement of cotton and the general understanding that, in view of the great area involved in the hostilities, it would not be reasonable to expect a normal demand for the staple to manifest itself. With the exchanges closed, and with shipments of cotton interrupted, the price was unstable and abnormally low, many sales undoubtedly having occurred at five cents per pound. Inasmuch as the cotton crop is raised very largely upon credit, it was necessary to provide some means whereby the Southern planter could be assisted to such extension of accommodation as he might require in meeting the obligations he would ordinarily have provided for by the sale of his crop in the open market. Various suggestions were brought to the attention of the Federal Reserve Board, one of them being that of Mr. Festus J. Wade of St. Louis, who suggested, both to the Board and to the Secretary of the Treasury, the establishment of a cotton loan fund somewhat similar in purpose and management to the gold exchange fund. After very anxious consideration, the conclusion was reached that some measure of the sort would probably furnish relief to cotton-growers. Various conferences were held with banking interests for the purpose of securing their co-operation and advice in regard to the matter. Ultimately the bankers of New York pledged fifty million dollars in subscriptions to the fund, provided that fifty millions more should be raised from other bankers in non-cotton-producing states. It was understood that to the one hundred million dollars thus raised should be added thirty-five million dollars contributed by the bankers of the cotton-producing states under a special plan devised for that purpose.[314]

IV

It was not, however, through any of these artificial means that real relief was brought to the community. While bankers were laboring to perfect the gold fund, and while the negotiations with Great Britain were in progress, foreign trade was being re-established through the effective policing of the North Atlantic, the re-establishment of demands, and the resumption of the ordinary course of business. What took place during the months of August and September can be understood from ... comparative figures for importation and exportation which make an impressive showing of the suffering to which the United States was subjected through this decline in business. With the opening of October there came, however, a decided improvement. Time had now been given for the establishment of normal conditions....

V

With foreign trade in a fair way to recover, it was still necessary to secure a restoration of normal trade conditions within the United States, and for this purpose the thing most fundamentally necessary was the setting in motion of the federal reserve banking system which had been provided for by act of Congress the 23d of December preceding. The time intervening between December 23, 1913, and the opening of the war had been occupied in carrying out the preliminaries of organization; but it still remained for the Federal Reserve Board, the controlling mechanism of the new system, to appoint officers and to provide for the active operation of the banks under its direction. The first detail to which the Board necessarily addressed itself was the completion of the boards of directors of the several institutions, it being necessary to select and elect three in each institution, or thirty-six in all. The task required an elaborate process of comparison of the names and qualifications of the several candidates and was not completed until early in October. With the announcement of the thirty-six directors, it was possible to proceed to the active opening of the institutions. The Board called for the first payment of capital stock on November 2, and the Secretary of the Treasury, who by law had been vested with that function, named November 16 as the actual date for opening....

The establishment of the system ... greatly relieved the banking situation.... Sec. 19 of the Federal Reserve Act provided for a readjustment of reserves upon a new and lower basis....

This readjustment, by the terms of the law, took effect immediately upon the establishment of the new banks, _i. e._, on November 16. From the outbreak of hostilities in Europe, there had been a difficult reserve situation in most of the financial centers, New York banks particularly being much of the time largely under their reserve requirements because of the heavy drafts made upon them by interior banks and by the public. The change in reserve requirements, however, made a very material alteration in this condition of affairs, and released, not only in New York, but throughout the country, a very considerable amount of funds which had previously been held by the banks in order to bring themselves within the requirements of law. Precisely what amount of reserves was thus released throughout the country has not been accurately estimated, and probably cannot be. It is, however, an undoubted fact that the release of actual cash was very large, and that the release of lending power as computed on the basis of reserves on the part of member banks was correspondingly larger. Member banks were thereby enabled to extend loans to their customers very much more freely than they had previously been able to do, while at the same time they were able to grant lower rates of interest in due proportion. The prevailing rate of discount for prime commercial paper in New York at the beginning of November was about 6 per cent., while other paper was considerably higher than that figure, and even more difficult conditions prevailed elsewhere. The opening of the reserve system enabled New York banks, because of the very great relief given to them through the release of reserves, to reduce this rate largely, and within two weeks after the new banks had come into existence prevailing interest rates for the best paper went as low as 3-1/2 per cent. and 4 per cent. while acceptances, which had been provided for by the Federal Reserve Act, were marketed at a still lower rate. In some parts of the South, Northern bankers were able to grant accommodation as low as 4 per cent. and in considerable amounts. In view of the greater ease and material relief which was thus accorded, the federal reserve banks were naturally not called upon to assist member banks with accommodation, such banks naturally refraining from asking aid when they themselves were fully able to meet the situation.

The opening of the reserve banks released, as already shown, a large amount of bank funds, and thereby rendered it possible to extend many loans which otherwise could not have been carried by the banks. It was also seen, soon after November 16, that the existence of the cotton fund, as was the case with the gold fund, had done its work by stimulating confidence and by leading to a more liberal extension of credit. With the cotton fund available for long-time loans, and with short-term credit much more freely extended by member banks in view of the reduction of national bank reserve requirements, it was possible for the reserve banks to open with full confidence that the work thus done in safeguarding the situation would relieve them from undue strain, while fully protecting the cotton-producers who were willing to pay a moderate rate of interest in order to carry their cotton until such time as would enable them to realize full market value for it.

As has been shown by the Secretary of the Treasury in his annual report,[315] an early phenomenon of the war was the issue by clearing-houses in many cities of clearing-house certificates. Simultaneously therewith large quantities of emergency currency were issued under the provisions of the act of 1908, which had been amended and extended by the Federal Reserve Act, and which were still further amended by Congress on August 4, so as to permit the freer issue of notes.... The total amount of the emergency currency taken out by associations had aggregated about three hundred and eighty million dollars, but it is probable that the clearing-house certificates were issued to a considerably larger sum. The channels of circulation were thus clogged long before the end of the summer, notwithstanding the fact that large quantities of gold and gold certificates were withdrawn and hoarded either by banks or by individuals. This condition of affairs made it certain that the reserve banks, upon their organization, would not be instantly pressed for the issue of reserve notes. Two factors combined to produce this result--the circumstance that many banks had placed their best paper with the national currency associations in order to protect emergency currency, and the further circumstance that the tax on this currency at the lower rate established by Congress would not, for some considerable time, be likely to approximate the rate of discount which every bank would have to pay to federal reserve banks in order to get the rediscounts that would enable them to obtain the notes they needed. Combined with these factors was, of course, the natural inertia which in all such cases tends to prevent the withdrawal of one kind of currency and the issue of another. Upon the organization of the federal reserve banks, moreover, the urgent pressure for note accommodation passed away as quickly as it had come. Gold reappeared in circulation at an early date, and the retirement both of the clearing-house certificates and of the emergency currency was undertaken. In those cities where rates of interest on clearing-house certificates were very high, the reserve banks aided in the retirement of the certificates remaining in circulation.

The emergency currency itself immediately began to be retired by its issuers.... Had the reserve banks been in operation at the beginning of August, they would naturally have supplied the great volume of currency which was called for; but not having done so, a field of business which would naturally be theirs has been temporarily taken from them by reason of the fact that it was occupied by the clearing-house certificates and emergency notes.[316]

VI

The result of the restoration of trade, banking, and credit to earlier and more normal conditions has been steadily apparent. Cotton exchanges reopened on November 16, and stock exchanges opened for restricted trading shortly thereafter. In brief, by the close of the year, the phenomenal conditions growing directly out of the European war had been met and overcome. It is a notable fact that under the wholly unusual circumstances prevailing, the recovery was so prompt and effective. What share in this early improvement is to be assigned to the organization of the new banking system and to the effectiveness with which the Treasury Department co-operated in meeting the needs of the country cannot accurately be stated, and will probably afford grounds for difference of opinion. That it was great cannot be denied....

NATIONAL BANK FAILURES AND SUSPENSIONS--1914 COMPARED WITH 1893 AND 1907[317]

A comparison of the failures and suspensions of national banks during the past year with failures and suspensions in the panic periods of 1893 and 1907 may be interesting at this time.

The figures show that for the 12 months ended October 31, 1914, 26 national banks, with aggregate capital stock of $2,510,000, failed or suspended payment. The total liabilities of these banks (in the case of receiverships claims proved) amounted to $14,177,408. In the case of six recent failures, the figures of total liabilities, less capital, surplus, and undivided profits, are used in lieu of the "claims proved," no report of the latter having yet been received as to these six banks.

For the 12 months ending October 31, 1893, 158 national banks suspended, with capital of $30,350,000. Sixty-five banks, with total capital stock of $10,935,000, were insolvent and required the appointment of receivers; 86, with capital stock aggregating $18,205,000, were able to resume business; and 7, with capital stock of $1,210,000, were placed in charge of examiners in the expectation of resumption. The total liabilities of failed and suspended banks for the period mentioned was $83,042,347--in the case of failed banks, "claims proved" being considered as "total liabilities."

During the six-months period from October 1, 1907, to April 1, 1908, there were 22 national bank failures and suspensions, and the total liabilities (in the case of receiverships these being "claims proved") were $32,443,978; the total capital stock, $6,540,000. Of these banks, however, 7, with capital stock of $1,440,000 and liabilities of $22,124,662, resumed business.

It is worthy of special note that in the crisis of 1914, unlike the panics of 1893 and 1907, there was no suspension of currency payments on the part of the banks of this country, either in the large cities or in the smaller towns. In the panics of 1893 and 1907, in addition to clearing-house checks, many artificial methods of supplying a temporary currency were resorted to, while actual currency commanded a premium of from 3 per cent. to 5 per cent.--$100 in currency costing anywhere from $103 to $105, or more, in certified bank checks.

In 1914 the banks of the country were enabled, as a result of the instant and active co-operation of the Treasury Department, and through the operations of the act of May 30, 1908, as amended by the Federal Reserve Act, to supply actual currency, even during the period of greatest stringency, to their customers and correspondents, both over the counter and in response to requests for shipments. Whenever any indications were seen of an attempt or disposition on the part of any solvent bank or banks to withhold or suspend cash payments, the subject was taken up immediately by the Treasury Department, and payments of currency over the counter and shipments by the banks upon demand, from the centers to the nearby and far-off districts, and vice versa, have been maintained practically without interruption throughout this crisis.

THE EFFECTS OF THE WAR WITH SPECIAL REFERENCE TO THE CENTRAL BANKS OF FRANCE, GERMANY, AND ENGLAND

I

[318]In France the gold held by the Bank of France (February, 1916) is, in actual quantity, larger by about 25 per cent. than that held in normal times before the war. Instead of former gold reserves of about $800,000,000, they are now well over $1,000,000,000. The percentage of gold to the notes--the main demand liability--has, of course, fallen from about 65 to 35 per cent. because of the increase of notes from about $1,200,000,000 to $2,800,000,000.

This increased supply of gold has come from hoardings and private holdings which have been placed at the disposal of the bank in return for bank-notes. There has been no reduction of this gold fund through demands from note-holders, since the bank was freed from redemption in gold at the very beginning of the war. That is, notes of the Bank of France are inconvertible. As contrasted with the dollar of the United States, when expressed in bills of exchange between New York and Paris, the Bank of France note has depreciated nearly 14 per cent. Any paper money not having immediate redemption will depreciate. As regards the future it is a question of ultimate redemption.

With so large an available gold supply, there can be little question as to the future intention or probability of redeeming the notes in gold. It looks very much as if the same policy adopted in the war of 1871-3 had been consciously followed. Then, also, the _cours forcee_ was declared, and the gold carefully retained in the vaults of the bank. The presence of a large gold fund was an assurance of the ability to return to specie payments after the close of the war. The war was short, and the notes were not seriously depreciated, bearing a discount as compared with gold of 1-1/2 to 4 per cent. In the present war, the same steps have been taken; but this war is extending over a much longer time than the former one, and the depreciation has already become much greater.

It is equally clear, however, that if the gold were now to be paid out for redemption uses, it would become scattered, exported, and might even pass through Holland or Switzerland into Germany. The increase and preservation of this large fund of gold is the strongest evidence of the ability of the bank to resume the gold redemption of its notes soon after the close of the war. The actual time, however will depend upon the rapidity with which the Government can repay some of its large loans from the bank, since the excessive note issues have been largely due to loans to the State.

II

In Germany, likewise, every effort has been made to accumulate gold, even though the notes of the Reichsbank were made inconvertible at the beginning of the war. Not only was the requirement to redeem the notes in coin removed, but the regulations regarding a tax upon all notes uncovered by a specie beyond a specified _Kontingent_ were suspended. Thus, restrictions on the limit of note issues do not exist; and they have risen from about $500,000,000 before the war to about $1,500,000,000 (February, 1916), while the stock of coin and bullion has changed from about $300,000,000 to over $600,000,000. That is, the coin, which is mostly gold, is about 40 per cent. of the notes. Here, again there is an obvious tendency to increase and maintain the gold reserves so that Germany may have the means of resuming gold payments at no great time after the close of the war.

The campaign to collect gold from the public and from hoards was remarkable. It was successfully made a test of patriotism to hand in gold in return for Reichsbank notes, and a house-to-house canvass in many places resulted in providing the gold which so signally increased the reserves behind the notes. Of course, the usual international operations for obtaining gold were denied to Germany. It was this campaign which was imitated by France. At the present time, certainly, no thought has ever occurred to Germans that they would not go back to a gold basis.

Nevertheless, Germany has clearly fallen into the same confusion of mind which characterized our own policy in regard to the issue of greenbacks in the Civil War. We confused the monetary with the fiscal functions of the Treasury. So has Germany. Thinking the war would be short and decisive, to be followed by large indemnities levied on her enemies, she had expected to finance her expenditure by temporary expedients. That is, the Government was led into the policy of borrowing through the increase of monetary forms.

It does not change the principle that this increase of paper money was not made solely by Imperial Treasury notes, but by a very large addition to the circulation in the form of Reichsbank notes and _Darlehnskassen_ notes. It was the loans by the Reichsbank to the Government which undoubtedly caused the main increase in the notes of this bank (just as was true of the Bank of France), and the reduction of these issues, and their redemption in gold, will depend directly on the power and readiness of the Government to pay off its obligations to the Reichsbank after the war.

The amount of borrowing by processes which led to an increase of the circulation was necessarily limited; and very soon borrowing through issues of paper money had to be followed by regular fiscal operations in the form of long- or short-term bonds which would not affect the quantity of the circulation. Expenses could not well be met to any extent by current taxation, because taxes were already high, and in the few years before the war, no doubt in anticipation of it, some four or five hundred million dollars in taxes over and above normal taxation had already been levied. In 1913 a non-recurring tax of $250,000,000 had been imposed on the wealthier classes.

In addition a bonded debt, since the war, has been floated to the amount of $10,000,000,000 over and above the existing public debt before the war of about $1,200,000,000. But all these fiscal operations should be, for our present purposes, separated from monetary operations. The carrying of these heavy government debts is a question of the future production of goods, of commerce, and of saving.

Whatever the burden of debts, the gold question is concerned with the mechanism of exchange by which taxes, subscriptions to loans, payments by the Government for munitions and supplies, current purchases of goods by the public, payments to and by banks, are made. At present this medium is paper money depreciated, as in the case of the Reichsbank notes, by nearly 30 per cent. Of course, the Darlehnskassen issues would follow the value set by the notes of the Reichsbank.

It is interesting to mention that the increase of paper money has not been in answer to any need of the public for additional media of exchange; for ordinary business transactions have decreased, and would require a less quantity of money. It was an error not to separate borrowing entirely from monetary issues.

Moreover, as bearing on the maintenance of the gold standard after the war, it is worth noting that the rule requiring the Reichsbank to keep one-third of its note issues covered by gold has not been violated. At last reports (February, 1916) the gold item stood at $613,750,000, as against $1,612,500,000 notes, or about 38.1 per cent. That is, the greatest efforts have been made to concentrate the gold holdings of the nation, including the "war chest" of about $30,000,000, in the reserves of the Reichsbank.

At the same time no gold is paid out in redemption of notes, nor is it allowed to be exported. Some sums have been sent to Holland in a vain attempt to support German exchange in that country; but the difficulty in exchange rates lies deeper than the relative supply of and demand for bills, since the depreciation of German paper money determines the general level about which the fluctuations of exchange due to demand and supply range. In fact, wherever gold is not freely moved in international exchange there are no shipping points, and hence no limits to which exchange can fall short of the discount of the paper in terms of gold.

III

As regards Great Britain, the gold standard is yet preserved for all practical purposes. To her credit be it said that she has not fallen into the error of borrowing by excessive issues of paper money; so far she has not confused the fiscal with the monetary functions of the Treasury. She resorted at once to fiscal operations in the form of heavy taxation and loans in the form of short-time Treasury bills and longer-term bonds. The issue of government paper money is, indeed, a new departure; but its purpose has been more distinctly monetary than fiscal.

The currency notes are emergency notes, issued under the act of August 6, 1914, directly by the Treasury, and not by the Bank of England, although authorized by the same act which suspended the Bank Act in regard to additional issues of bank notes not covered by gold. In other crises the act of 1844 has been suspended to allow more notes based on consols than permitted by the act (_i. e._, above the L18,750,000). In August, 1914, such a suspension was in the future made legal, if authorized by the Treasury, thus avoiding the old resort to a bill of indemnity by Parliament.

But in spite of the usual suspension of the Bank Act, no use was made of it. That is, a demand for more currency in the hands of the public could have been supplied by the bank, but was not. In truth, the Lloyd George currency notes need not have been issued. Nevertheless, when once issued, they made unnecessary any resort to additional Bank of England notes. There was no need of both. But in one respect the currency notes helped to maintain the country's gold standard. By issuing them in small denominations of one pound, and ten shillings, they replaced the gold in general use for these denominations, and allowed it to be used as reserves. Yet, it must be remembered that sound policy required a gold reserve (which has been generally kept at about 40 per cent.) behind these currency notes, so that the whole amount of gold replaced was not, in fact, a gain.

As all know, the question of gold for Great Britain pivots on the reserves of the Bank of England, which is the agent for the Government, receiving its taxes and paying out its expenses, as well as the holder of reserves for other banks--being thus a bankers' bank, as well as a national agent. Moreover, the reserves mentioned, and which are of prime importance, are those of the banking department--and these are chiefly Bank of England notes (not gold). The percentage of reserves to deposits, which marks the safety line for England, refers to the items in the banking department. These notes, however, are protected (except the bottom layer of L18,750,000 covered by consols), pound for pound, by gold in the issue department. Hence, they can be turned into gold at any moment.

Then, to what do these facts lead us? Simply that gold has increased just in proportion to the issue of bank notes. In addition, the currency notes of the Government served in the place _pro tanto_ of the Bank of England notes. Hence, at the end of the war, the provision for redemption of Bank of England notes will work automatically. Nor can there be any question as to the gold being there to redeem them; for they cannot get out without a previous deposit of gold. Indeed, the questions of difficulty cannot arise regarding the basic currency of Great Britain; they will arise, if at all, in connection with the assets in the loan item of the banking department, since they will determine the safety of the deposits chiefly created as the result of loans. The bank discounted large sums of pre-moratorium acceptances and paper; and yet even in these assets it is protected by the guarantee of the Government.

DARLEHNSKASSEN AND OTHER FINANCIAL NOVELTIES IN GERMANY

[319]Germany, at the outbreak of the war, removed the limit of notes issuable by the Reichsbank without tax; created about 1,800 Darlehnskassen (loan banks), located throughout the Empire, wherever the Reichsbank maintained a branch; they were started without capital, in lieu of which they issued _Darlehnskassen Scheine_ (Imperial Loan Bank notes) in denominations of one mark and upwards, the aggregate amount being limited to 1,500,000,000 marks; these banks made loans against stocks, shares, produce, any personal property of a non-perishable character, as collateral, and issued certificates, having the quality of bank notes, to the borrowers; the loans ran for three and sometimes six months; the minimum loan was 100 marks; a very wide margin of safety was required, making the loans good beyond question; these certificates were receivable for public dues and by the Reichsbank; the smaller denominations circulated as money, the Reichsbank received the larger, giving its notes in exchange; these certificates were not legal tender, but were given the quality of gold and "may be considered by the Reichsbank as gold cover, which means that against 100 marks of these Scheine in its vault the Reichsbank is allowed to issue 300 marks of its own notes." (I. De Bruyn.)[320]...

Sir Edward H. Holden, president of the London City and Midland Bank, in a speech to his board of directors, January 29, 1915, said:

Germany proceeded to establish War Loan Banks, War Credit
Banks and War Aid Banks under the patronage of corporations,
municipalities and private financiers, and to make use of
the Mortgage Banks already established....

The Mortgage Banks are under the control of Chambers of
Commerce and municipalities, and they make advances on the
mortgage of properties by an issue of notes....

Germany made greater use (than of the Darlehnskassen) of the
Mortgage Banks, the notes of which are identical in power
and use with the notes of the Darlehnskassen. Another part
of their scheme was to relieve the pressure on insurance
companies (life), by forming an insurance bank, which
advanced 40 per cent. on the value of policies. These
advances were paid on notes which were exchanged for
Reichsbank notes in the same way as the notes of the
Darlehnskassen and Mortgage Banks.

Germany, with characteristic system and detail, provided different kinds of banks to deal with different phases of the situation. War credit banks were designed to aid Germans whose credits became unavailable, owing to the exigencies of the war, as for instance those who had sold and shipped goods abroad (the enemy's country), whose accounts would be temporarily uncollectible, and those who might be otherwise embarrassed in their foreign trade because of the interruption of business caused by the war. War credit banks were more general in their dealings than war loan banks. In Germany, business is largely done upon credit, and especially so by small concerns and individuals, who possess no extended bank credit nor available collateral, and hence are not in position to make use of the Reichsbank or other commercial banks, or the Darlehnskassen.

A German banker says: "It was deemed advisable to create an institution of an intermediary character which would bear the greater share of the risks involved. The so-called war credit banks are designed to serve this purpose. They were established throughout the country, have their own capital, and the obligations undertaken by them are guaranteed, and losses, if any, refunded by the respective municipalities and commercial associations. The war credit bank of Greater Berlin, for instance, was established with a capital of 18 millions of marks, of which 25 per cent. are fully paid in. In addition thereto, there is a liability of 11.5 million marks by official bodies of commercial organizations."

Still another kind of war credit bank was created on the co-operative plan to assist the middle and lower classes.

Through the instrumentality of these institutions, a large amount of credit instruments, possessing a currency function, was brought into existence in Germany....

THE WAR AND THE WORLD'S FINANCIAL CENTRE

[321]With the end of the moratorium on November 4, it may be said that the crisis produced by the outbreak of war was over. When peace comes and prices [of securities] adapt themselves to the new price of capital that the present destruction of some eight to ten millions of it a day will bring about, and creditors begin to try to collect debts from impoverished debtors in war-wasted countries, then there will be a new set of problems, the acuteness of which will largely depend on the length of the war and the extent to which the fighters are worn out. These problems will exercise all the ingenuity and strength that Lombard Street can muster. For the present it is enough to see how we stand at the end of the opening period of the war, and what have been the effects of the financial tornado with which its beginning was heralded....

The crisis of last August was the greatest evidence of London's strength as a financial centre that it could have desired or dreamt of. It was so strong that it did not know how strong it was. Consequently, being a little flustered by the suddenness of the outbreak of war, on a scale that mankind had never seen before, it made the mistake of asking its debtors to repay it, not the thousands of millions that it had lent in the form of permanent investment, but the comparatively trifling amount--perhaps 150 or 200 millions--that it had lent in the shape of bills of exchange drawn on it, and other forms of short credits. Thereby it put the rest of the economically civilized world, for the time being, into the bankruptcy court, and so, finding that none of its debtors could pay, it thought itself obliged to ask for time from its own creditors at home. Foreign creditors it had none, except Paris. It sent gold to Paris as fast as it could be shipped and insured, and so seems to have liquidated its debt. For when a market in exchange reopened after the first shock of war, the Paris cheque soon steadied itself at a more or less normal level, above the point at which gold could be sent to France as an exchange operation. It is possible, however, that London was still in debt to Paris, and that Paris preferred for obvious reasons to leave its money on this side of the Channel.

Of the three possible rivals to London as a financial centre, Paris was the only one that gave any evidence of real financial strength. Behind Paris stands the enormous power of the thrifty French investor, who probably accumulates a greater proportion of his income than anybody in the world, except, perhaps, some classes of Scotsmen. This accumulating power of the French gives the Paris money market a position of first-rate importance in the financial world, because capital has to be saved, and a saving people has capital to lend. The advantage that London holds in its more elastic credit system is partly balanced by the advantage given to Paris by the thrifty habits of the French people. If Paris adopted a more businesslike policy with regard to her huge store of gold, which she has hitherto seemed to regard as a precious asset to be sat on and protected by the charge of a premium to audacious people who want to withdraw a bit of it, she might, in normal times, be a much more dangerous rival to London than she is. But it need hardly be said that Paris, as a financial centre, was soon wrapped in the cloud of war and invasion, and had no chance of making any effort to oust London from her pride of chief place.

Berlin was equally cut off from competition, for Berlin had to devote herself to the task of financing war for Germany. Moreover, the rapid depreciation in the value of the mark that took place before the war began showed that Germany was still a debtor country in the short-loan market. The Berlin exchange, while war was as yet only a dreaded possibility, rose from 20 m. 50 pf. to 20 m. 60 pf. Germany invests money abroad, but she seems to borrow as much, and more, in the discount markets of London and Paris. So it came to pass that, in spite of the big sales of securities that she had thrown on the markets of New York and London, she still had to pay when the big day of settlement came, and to pay so fast that she had not a bill on London left to pay with.

It was the chance of a century for New York. American ambition has long ago informed the world that the United States, having been the world's granary, is now the world's most progressive manufacturer, and means soon to be the world's banker. This may happen some day, and might have happened already if American policy in currency, financial and fiscal matters had been more enlightened, and if her people had been more thrifty. But they have tied their credit system in the bonds of narrow banking laws and their trade in those of a cramping tariff. These bonds they have just begun to shake off, and if the crisis had happened a few years later they might perhaps have made a bid for London's place as world banker. But it is hardly likely, for the development of the enormous resources of the country still craves for much more capital than its people can provide. The United States is still a debtor to the world at large and seems likely to be so for some time to come, and it is doubtful whether even New York, with all its skill in the jugglery of finance, can make itself a great banking centre as long as its heavy balance of indebtedness is always waiting to turn the world's exchanges against it, whenever the monetary sky is overcast.