Figure 15. Monthly bond yields, 1914–1945
Source: NBER, except German data kindly supplied by Joachim Voth.
It is illuminating to compare the fluctuations in the German bond market over the same period, though the data are not complete because of the disruptions caused by the 1923 hyperinflation, the 1931 banking crisis and the 1935 law imposing maximum interest rates. When the market was able to function more or less normally, however, the role of political events is once again apparent – in this case, mainly domestic political events. The two biggest jumps in yields occurred in June 1932 (8 per cent) and July 1934 (9 per cent). The first coincides with the political instability following Papen’s decision to dissolve the Reichstag and hold new elections, a decision that played into the hands of the Nazis and triggered unprecedented political violence in German cities. In 1934 the main political upheaval was the ‘Night of the Long Knives’ on 30 June, when over 170 radical Nazis and other politically ‘suspect’ individuals were murdered, including the leader of the SA, Ernst Röhm, and the former Chancellor General Schleicher.58 The reaction of the bond market to Hitler’s appointment as Chancellor was ambivalent: yields fell 6 per cent in January 1933 but rose the following month; fell again in March and April, but rose 4 per cent in May, the month of the anti-Jewish boycott.
For the rest of the Nazi period it is necessary to look outside Germany’s controlled economy for evidence of investor expectations. One illuminating study has looked at the fluctuations of prices of German bonds traded in Switzerland, which suggest a high level of investor pessimism about the Third Reich’s chances of victory in the Second World War. The Swiss market for German bonds fell by some 39 per cent in September 1939; it had already fallen 17 per cent in the wake of the invasion of Czechoslovakia the previous March. There were further drops as a result of reverses during the war – notably the entry of the United States into the war after Pearl Harbor (minus 5 per cent) and the Russian counter-offensive at Stalingrad in November 1942 (minus 7 per cent). And prices finally collapsed (by 34 per cent) after the Allied powers resolved to demand unconditional surrender at the Yalta Conference.59
A similar exercise can be carried out for American yields since 1919. Remarkably, the five biggest percentage rises in the yield on US long-term bonds all occurred between 1979 and 1984 (see Figure 16). It is at least arguable that the bond market was simply following the Federal Reserve’s increases in short-term interest rates. That was certainly the case in October 1979, when Paul Volcker introduced his new policy of controlling non-borrowed reserves and raised interest rates to 12 per cent.60 In the same month the long-bond yield rose 9 per cent or 76 basis points. However, yields rose twice as much (18 per cent or 152 basis points) in February 1980. Was this another response to monetary tightening? Or was it a reaction to the superpower tension sparked by the Soviet invasion of Afghanistan? This had begun on Christmas Day the previous year and had been denounced by President Carter on 8 January as the biggest threat to world peace since the Second World War. On 23 January, a day after martial law had been proclaimed in Kabul, Carter had gone further, warning the Russians against any interference in the Persian Gulf. A similar coincidence between politics and the bond market occurred in January 1982. On 29 December 1981 President Reagan had imposed economic sanctions on the Soviet Union in retaliation for the introduction of martial law in Poland. Bond yields rose by 10 per cent (85 basis points). There were somewhat smaller though still substantial rises in yields – both of the order of 8.7 per cent–in August 1981 and May 1984. On 9 August 1981 Reagan announced his decision to proceed with the manufacture of the neutron bomb; ten days later US planes shot down two Libyan fighters. On 24 May 1984 Iranian planes attacked oil tankers off the coast of Saudi Arabia, prompting the US to send Stinger anti-aircraft missiles to the Saudis.
Figure 16. US long-term bond yields, 1979–1989
Source: Federal Reserve Bank of St Louis.
At this stage, it would be unwarranted to regard these as any more than coincidences: a formal demonstration that there is a causal relationship between political events and bond market crises comes later. However, it is possible to strengthen the presumption of a causal link by making use of weekly data and comparing these with contemporary financial commentary. To this end, I have calculated weekly fluctuations in consol yields for the period 1845–1910 and analysed the editorial analysis of the London market in The Economist. As this was the period when yields were at their most stable – the market was liquid, Britain was on gold and, with the budget usually in surplus, there was no question of default risk – weekly fluctuations were relatively low. However, there were significant movements and, because of the importance of the consol market to its readers, The Economist followed these closely.
Once again it is remarkable that the biggest short-run jumps in yields occurred on dates that mean more to the political than the economic historian. Thus the biggest shock to the bond market in the period happened immediately after the outbreak of the 1848 revolution in Paris (which began on 22 February, too late to affect British markets in the week ending 24 February). Between that date and 3 March, the yield on consols rose by 7.6 per cent.61 As in 1830, a French revolution was worrying to British investors mainly because memories of the 1790s led them to expect war with a revolutionary France. On 31 March The Economist described a further 2.4 per cent rise in yields as a ‘consequence of the increased likeliness of war breaking out’.62 Wars also seem to account for the second and third biggest jumps in yield, in the weeks ending 31 March 1854 (4.2 per cent) and 29 April 1859 (6 per cent). On 28 March 1854 Britain had declared war on Russia. On 17 November the magazine noted another steep fall in consol prices, attributing the decline to ‘the impression that there was a great deal more work for the English troops to do in Crimea than had previously been expected’.63 Austrian forces crossed the Sardinian frontier on 29 April 1859, ten days after their ultimatum to Count Cavour’s government to disarm: as The Economist remarked, ‘hopes of peace had clearly been cherished up to the latest moments’.64
If the analysis had been extended seven years further, second place would have been taken by the week ending 31 July 1914, when consol yields rose 6.6 per cent. Had the stock market remained open after 1 August 1914, the following week would have seen an even bigger rise in yields than in 1848. The 5 per cent drop in bond prices on the day Germany declared war on Russia (1 August) was, according to The Economist, unprecedented, as was the widening of the bid–ask spread to a full percentage point, compared with a historic average of one-eighth.65
But how can we be sure that these were not exceptional coincidences between political and economic crises? Table 7 presents an analysis of Economist editorial comments on significant movements in the consol market. For the sake of clarity, I have distinguished between twenty-two different explanations offered by the magazine for increases in UK yields, adopting the distinctions made at the time even when these seem by modern standards to overlap.
Such statistics should, needless to say, be used with caution. However, they do offer some insight into the way contemporaries thought, and hence into the way that expectations were formed. A striking result is the very high proportion of movements in the consol market attributed by The Economist to exogenous political events: primarily the possibility of war, or some other international development. Together these account for more than a quarter of the explanations the magazine offered for significant market movements. The proportion of references to changes of fiscal and monetary policy was only fractionally higher, with action by the Bank of England the single most frequent explanation for movements in yields. (Interestingly, The Economist usually distinguished between changes to short-interest rates which it saw as arising spontaneously in the money market, and those which were due to specific action by the Bank of England.) Certainly, the table serves to illustrate the wide range of influences that acted on the bond market, including even the weather (primarily because of its impact on agriculture
). Yet there is no question that political events loomed large.
To the economic determinist, it is economic change that shapes political events. But in the financial markets political events have economic consequences too. In fact, the direction of causation runs both ways. When a political crisis causes a rise in yields of as much as 178 basis points (as happened in Britain in June 1974), its economic consequences extend far beyond the bond market as the whole structure of interest rates in the economy changes. Above all, the government faces a rising cost of borrowing in nominal if not in real terms – a matter of some importance when, as was the case then, both the deficit and debt interest amounted to more than 4 per cent of GDP.
Asked to name the principal danger that any government faced, Harold Macmillan famously replied: ‘Events, dear boy, events.’ The dictum applies to all who borrow money – as Antonio found out when events sank his ships. But it applies with especial force to a government with a large amount of short-term debt.
Table 7. Determinants of fluctuations in the price of consols, 1845–1900, as cited in The Economist
Note: The system employed here was to take notes from each issue of The Economist in which explicit explanations for changes (or lack of changes) in the price of consols were published and to divide explanations into categories. The above total refers to the number of references to particular factors. The total number of editorials from which notes were taken was 889. Often, a single editorial offered more than one explanation. Percentages may not sum exactly due to rounding.
SECTION THREE
ECONOMIC POLITICS
7
Dead Weights and Tax-eaters: The Social History of Finance
This is the way that our crew beat the people of France. They laid out, in the first place, six hundred millions which they borrowed, and for which they mortgaged the revenues of the nation. Then they contracted for a dead weight to the amount of one hundred and fifty millions. Then they stripped the labouring classes of the commons, of their kettles, their bedding, their beer-barrels; and, in short, made them all paupers, and thus fixed on the nation a permanent annual charge of about 8 or 9 millions, or a gross debt of £200,000,000. By these means, by these anticipations, our crew did what they thought would keep down the French nation for ages; and what they were sure would, for the present, enable them to keep up the tithes and other things of the same sort in England. But the crew did not reflect on the consequences of the anticipations!… These consequences … are coming …
COBBETT, Rural Rides1
There is no need to subscribe to Marxism to believe that class division was the most important social consequence of capitalism. Émile Zola memorably described in L’Assommoir (1877) how the workers led the social cavalcade that began every day at 6 a.m. in the Boulevard de la Chapelle, near the Gare du Nord:
You could tell the locksmiths by their blue overalls, masons by their white jackets, painters by their coats with long smocks showing underneath. From a distance this crowd looked a uniformly nondescript plaster colour, a neutral tone made up chiefly of faded blue and dirty grey. Now and again some workman would stop to light his pipe, but the others tramped on round him with never a smile, never a word to a mate, pasty faces all turned towards Paris, which swallowed them one by one …
By 8 o’clock, however, the scene had changed:
After the workmen came the workgirls – polishers, dressmakers, florists, huddled up in their thin dresses, tap-tapping along the outer boulevards in threes and fours, chattering away and giggling, darting keen glances about them … Next the office workers passed along, blowing on their fingers and munching their penny rolls as they walked; lean young men in suits a size too small … or little old men with toddling gait and faces tired and pale from long hours at the desk, looking at their watches to regulate their speed within a second or two. And finally … the local well-to-do … taking their stroll in the sun.2
The seriously rich – like the family that had financed the construction of the magnificent Gare du Nord itself, the Rothschilds – would rarely have been seen in such a quarter.
As Zola’s description makes clear, there were numerous gradations within the working class, according to occupation, sex and age: these different strata were even distinguishable by the time they got out of bed. Yet – and this was Marx’s point – these were manifestly less important than the fundamental division between the property-less mass and a propertied élite. Nor is there any doubt that the processes of industrialization and urbanization made that division wider. Merchants, industrialists, proprietors and rentiers held 53 per cent of all wealth in Paris in 1820. By 1911 the figure was 81 per cent.3 The same was true elsewhere. Between 1850 and 1880 the British economy grew in real terms by around 130 per cent. According to the most recent research, however, average real earnings rose by just 25 per cent.4 During the same period, thirty-nine individuals died leaving estates worth more than a million pounds: eighteen industrialists, twelve bankers, four landowners, two merchants, two shipowners and a builder. The combined value of their estates – £57 million – was equivalent to around two-fifths of gross national product.5
Yet for all their obvious utility and subjective resonance,6 the categories of class have their limitations. In particular, the role of the state as an instrument of redistribution is not easily explained in terms of class, unless the state is simplistically regarded (as Heinrich Heine once jokingly suggested) as the ‘supervisory board of … bourgeois society’.7 For large public debts have, since their origin on the eve of the industrial revolution, generated conflicts of interest between bondholders and taxpayers: groups that have seldom been as entirely distinct as the propertied and the property-less.
It is, of course, possible to translate fiscal conflicts into the language of class using the tripartite model favoured by economists since Ricardo, and adopted by Marx, which divides society into rentiers, entrepreneurs and workers. But such an approach, however theoretically convenient, presupposes a somewhat unrealistic separation between social groups and indeed between different fiscal policies. For the growth in the number of state creditors – including not only bondholders but pensioners – creates complex overlaps which cannot be overlooked. Moreover, public debts also transfer resources between generations because, as we saw in Chapter 4, government borrowing today implies cuts in spending or increases in taxation at some future date. Given the fact that future generations do not vote and therefore have only indirect political representation (in the form of one or two legislators with abnormal foresight), the former relationships – between current taxpayers and recipients of benefits – tended for most of the twentieth century to be uppermost in the minds of policy-makers. But there is now a growing awareness that generational conflicts are no less important; and may indeed hold the key to the future of public finance.
THE BIRTH OF THE RENTIER
When monarchs relied on individual bankers for loans – and they continued to do so in many German states until the end of the eighteenth century – the bankers were, as we have seen, always vulnerable to default, often in the guise of prosecution for alleged fraud. In 1451, for example, the financier Jacques Cœur was forced to flee France after being accused of embezzlement.8 Periodic ‘purges’ of royal creditors soon became institutionalized in the form of chambres de justice. Even into the eighteenth century financiers remained vulnerable to such treatment, especially if they were Jews, as the case of Josef Süss Oppenheimer illustrates. Oppenheimer rose from being the Duke of Württemberg’s Hoffaktor (court agent) to become his privy councillor and, in 1733, his envoy in Frankfurt. Four years later, however, he was executed, having been found guilty of wielding excessive political power and undermining the position of the Württemberg estates (Stände). Contemplating the much greater power of the Rothschilds in his own day, Thomas Carlyle looked back with malign nostalgia on King John’s use of the ‘pincer’: ‘“Now Sir, the State requires some of these millions you have heaped together with your financing wo
rk. You won’t? Very well” – and the speaker gave a twist with his wrist – “Now will you[?]” – and another twist, till the millions were yielded.’9
When public creditors formed a more numerous class, by contrast, they could become politically formidable. As early as the Renaissance, the sophisticated public debt systems of the Italian city-states brought into being rentier-like groups. In Genoa the comperisti were able to secure permanent political representation in 1323 in the form of elected protectores comperarum.10 In Florence there were about 5,000 creditors of the Monte in 1380, heavily concentrated in the top decile of wealth holders.11 The nearest equivalent in medieval England was the power of the merchants of London. Indeed, it has been suggested that Henry VI’s fall from power was related to the decision by the London merchants to end their financial support of the Lancastrian regime.12 Charles I too owed his downfall in part to lack of credit. Though historians once tried to explain the English Civil War in terms of class – and memories of the ‘storm over the gentry’ have not altogether faded – the Stuarts’ failure to win the confidence of a relatively small group of actual and potential creditors mattered more. The Glorious Revolution saw the transformation of the sovereign debtor from the Crown into ‘the King-in-Parliament’. The emergence of the bondholders as an influential lobby within parliament reduced the risk of default by the British state and thereby increased the state’s capacity to borrow cheaply.13
The Cash Nexus: Money and Politics in Modern History, 1700-2000 Page 24