Disraeli was another eminent Victorian who grasped the interrelatedness of war crises and financial crises. In January 1859, on the eve of the Franco-Italian challenge to Austria, he wrote to the Earl of Derby: ‘The alarm in the City is very great: “the whole of the Mediterranean trade is stopped.” The reduced value of securities is not less than 60 millions sterling, the greater part in France. Another such week will break the Paris bourse. “And all because one man [meaning Napoleon III] chooses to disturb everything.”’62 Even the Marquess of Salisbury occasionally lapsed into the idiom of the stock exchange, observing drily (with respect to the lack of outside investment in Ireland): ‘Capitalists prefer peace and 3 per cent to 10 per cent with the drawback of bullets in the breakfast room.’63
Nor was this a peculiarity of British ‘gentlemanly capitalism’. When reflecting in January 1865 on the likely outcome of the struggle for mastery in Germany, one French diplomat commented shrewdly, if not quite accurately, that ‘Prussia stood above par in politics as on the bourse’.64 Bismarck too appreciated the significance of the bond market. Indeed, he relished putting one over on Amschel von Rothschild in February 1854, when he heard the news of the Russian ambassador’s recall from Paris: ‘I considered whom I could best frighten thereby. My eye fell on [Amschel] Rothschild. He turned as white as chalk when I gave him the news to read. His first remark was, “If only I had known it this morning”; his second, “Will you do a little business with me tomorrow?” I declined the offer in a friendly way, thanking him and left him to his agitated reflections.’65 Bismarck himself later became the object of speculation. When the British ambassador Lord Ampthill called on Gerson Bleichröder in 1882, he reported seeing a telegram (from the Paris Rothschilds) asking for immediate news of the Kaiser’s health. ‘I asked Bleichröder what effect French financiers expected from the Emperor’s death upon the Paris Bourse. “A general baisse of from 10–15 per cent,” he replied, “because of the uncertainty of Bismarck’s tenure of office under a new reign.”’66
EMPIRE
It is often forgotten that, until the end of the 1860s, France and Britain were more or less neck and neck as foreign lenders. Between 1861 and 1865 the value of government loans floated in Paris was almost exactly the same as the value of loans issued in London.67 It was only after the German defeat of France in the war of 1870–1 that Britain forged decisively ahead. If Europe was, in Herbert Feis’s famous phrase, ‘the world’s banker’, then from 1870 until 1914 Britain was the bank’s head office.68
There were two great waves of British capital export between 1870s and the First World War. Between 1861 and 1872 net British foreign investment rose from just 1.4 per cent of GNP to 7.7 per cent, falling back to 0.8 per cent in 1877. It then climbed back to 7.3 per cent in 1890, before once again dipping below 1 per cent in 1901. In the second upswing, foreign investment reached an all-time peak of 9.1 per cent in 1913 –a level not subsequently surpassed until the 1990s.69 In absolute terms, this led to a huge accumulation of foreign assets, rising more than tenfold from £370 million in 1860 to £3.9 billion in 1913 – equivalent to more than 140 per cent of GNP.70 Put differently, the share of British wealth invested abroad rose from 17 per cent in 1870 to 33 per cent in 1913.71 No other country came close to this level of foreign investment: the closest, France, had foreign assets worth less than half the British total, Germany just over a quarter. Britain accounted for something like 44 per cent of all foreign investment on the eve of the First World War.72 Far from ‘starving’ British industry of investment, as has sometimes been alleged, this capital outflow effectively paid for itself. In the 1890s net foreign investment amounted to 3.3 per cent of gross national product, compared with net property income from abroad of 5.6 per cent. For the next decade, the figures were 5.1 and 5.9 respectively.73
The reasons for the outflow have been endlessly debated ever since J. A. Hobson’s Imperialism (1902), which argued that Britain’s unequal society was generating more savings than could be invested at home. This does not appear to have been the case.74 Lenin’s argument during the war was that overseas investment had been a response to declining domestic returns; and subsequent research has found some evidence for this. Returns on domestic investments were markedly lower between 1897 and 1909 than they had been in the 1870s. Moreover, even allowing for the higher degree of risk involved, the returns on foreign securities were rather better (by between 1 and 2 per cent) than those on domestic securities when averaged out over the period 1870–1913.75 This averaging conceals substantial fluctuations, however. Domestic securities were sometimes a better investment than comparable overseas securities – for example, in the decade 1887–96 and in the last three pre-war years.76 A more recent interpretation relates capital flows to the high dependency ratios in the New World, where couples married young and had more and healthier children than their counterparts in the old country; savings rates were correspondingly low.77
As Hobson’s title suggests, writers have long tended to assume that there was a link between British capital export and British imperialism. There is certainly no question that the boom in overseas lending from London coincided with a dramatic expansion of British colonial rule. In 1909 the territorial extent of the British Empire was 12.7 million square miles, compared with 9.5 million square miles in 1860: an increase of exactly a third. Some 444 million people lived under some form of British rule on the eve of the First World War, a quarter of the world’s population. Only one in ten British subjects lived in the British Isles themselves.
It is true that between 1865 and 1914 only around a quarter of total British investment went to the Empire, whereas 45 per cent went to other foreign economies. Moreover, the overall rates of return on investments in the Empire seem to have declined in relative terms: they were around two-thirds higher than returns on domestic investments in the period before 1884, but two-fifths lower thereafter.78 By the late nineteenth century strategic considerations increasingly outweighed economic ones in extending the imperial frontier.
Yet this is not to say that overseas investment outside the Empire had no political significance. Between 1865 and 1914 around 35 per cent of all British overseas investment in quoted securities was in public sector bonds; while most of the rest was concentrated in sectors generally characterized by a high level of government interest, if not intervention, such as railways, mines and public utilities. Only 4 per cent was in manufacturing.79 In 1862 it was calculated that the aggregate capital of national debts in the world was £2.6 billion, of which more than a quarter was quoted on the London Stock Exchange. Ten years later the total had risen to £4.6 billion and the proportion quoted in London to 53 per cent.80 Foreign or colonial government issues rose from around 6 per cent of the total value of securities quoted on the London Stock Exchange in 1853 to 26 per cent in 1883 (see Figure 27). There were many countries which Britain could not govern directly, but whose governments were nevertheless dependent on British investors.
Figure 27. Government bonds as a percentage of all securities quoted on the London Stock Exchange, 1853–1990
Source: Michie, London Stock Exchange, pp. 88 f., 175, 184, 320, 322, 360 f., 419, 421, 440, 473, 521 f., 589 f.
Notes: From 1883 figures include foreign government bonds payable abroad but quoted on the London Stock Exchange. To 1933 nominal values; from 1939 market values.
The relationship between capital export and British imperialism – both formal and informal – is well illustrated by the contrasting cases of Egypt and Turkey. In the aftermath of the Crimean War, both the Sultan in Constantinople and his vassal the Viceroy (or ‘Khedive’) in Cairo had begun to accumulate huge and ultimately unsustainable domestic and foreign debts. Between 1855 and 1875 the Ottoman debt increased from around 9 million Turkish lire to around 251 million. In relation to the financial resources of the Ottoman government this was a colossal sum: as a percentage of current revenue the burden rose from 130 per cent to around 1,500 per cent; as a percentage of expenditure, in
terest payments and amortization rose from 15 per cent in 1860 to a peak of 50 per cent in 1875.81 By 1877 the Turkish debt had reached 251 million lire, of which, after commissions and discounts, the Treasury in Constantinople had received just 135 million. Nor was the money put to good use. Millions were squandered by the Sultan Abdul Mejid on the new Dolmabahçe palace, a seraglio with the proportions of the Gare du Nord.
The Egyptian case was similar: between 1862, the date of the first Egyptian foreign loan, and 1876, the total public debt rose from 3.3 million Egyptian pounds to 76 million, roughly ten times total tax revenue; in addition, the Khedive Ismail owed around 11 million pounds on his own private account. In the 1876 budget, debt charges amounted to more than half (55.5 per cent) of all expenditure.82 Compared with other major borrowers on the international market (such as Brazil or Russia), Turkey and Egypt were out of control. Brazilian and Russian debts were never much more than three times greater than total tax revenue, while debt service typically accounted for less than 15 per cent of total spending. In fact, the closest parallel to the Middle Eastern experience was in Spain, which also defaulted in the 1870s.
The gradual transformation of Egypt from an Ottoman fiefdom into a British dependency began with the declaration of Turkey’s bankruptcy in October 1874. It was this that forced the Khedive to offer his shares in the Suez Canal to the British government for £4 million – an enormous sum, equivalent to more than 8 per cent of the entire British budget net of debt charges, but one the Rothschilds were able to advance Disraeli in a matter of days, if not hours.83 In the wake of this coup, a new Caisse de la Dette Publique was established to place Egyptian finances under the supervision of representatives of Britain, France, Italy and Austria – the main creditor countries. It fixed the consolidated debt at £76 million (a figure that did not include £15 million of private debts secured on the Khedive’s lands and a substantial floating debt which may have been as much as £6 million).84 In 1878 the Caisse recommended that an ‘international’ government be appointed with an Englishman as Finance Minister and a Frenchman as Minister of Public Works.85 In April 1879, however, the Khedive dismissed the ‘international’ government, which had predictably made itself unpopular with Egyptian taxpayers. The powers duly re-imposed their authority by replacing the Khedive with his son Tewfiq; but a nationalist military revolt led by Arabi Pasha finally drove the British government to direct military intervention. In July 1882 Alexandria was shelled, and by September Arabi had been overthrown. It was the beginning of a prolonged, though never unabashed, occupation. Between 1882 and 1922 Britain felt obliged to promise the other powers no fewer than sixty-six times that she would end her occupation of Egypt. British troops did not leave until June 1956, returning briefly and ignominiously the following November in a vain attempt to prevent the nationalization of the Canal.
Though the occupation of Egypt was partly a strategic riposte to French activities in Tunisia, the financial rationale of the British action was thinly veiled. In 1884 the First Lord at the Admiralty, Lord Northbrook – a member of the Baring banking family – was despatched to Egypt to enquire into the country’s finances; his cousin Evelyn Baring (later Lord Cromer) was already in Cairo as consul-general. It was the latter Baring who did much of the work of stabilizing Egyptian finances.86 The absolute debt burden was reduced from a peak of £106 million in 1891 to just £94 million in 1913; simultaneous increases in taxation meant that the debt/revenue ratio halved. Yet Cromer was also able to raise enough new foreign money to carry out substantial infrastructural investments.87 This can hardly have been bad for Egyptians. It was certainly good for foreign bondholders. The British occupation of Egypt in 1882 pre-empted complete default and ensured an exceptionally high real rate of return on Egyptian bonds.88 The Canal shares also proved to be an extraordinarily good investment for the British Treasury. By January 1876 they had risen from around £22 to more than £34, an increase of more than 50 per cent. The market value of the government’s stake was £24 million in 1898,£40 million on the eve of the First World War and £93 million by 1935 (around £528 a share).89 Between 1875 and 1895 the government received its £200,000 a year from Cairo; thereafter it was paid proper dividends, which rose from £690,000 in 1895 to £880,000 in 1901.90
By contrast, Russian and later German interest in Constantinople made it impossible to go beyond great power supervision of Ottoman finances (the pagoda-like offices of the international Administration de la Dette Publique can still be seen in Istanbul today). As a result, Turkish government and finances carried on much as before. In 1889, after the major debt rescheduling of 1881, the debt/tax revenue ratio was 8.7 : 1; by 1909 it was back above 10, as it had been in 1879. As a percentage of expenditure, debt service rose from 12 per cent in 1890 to 33 per cent in 1910, the year of the Young Turks’ revolt.91 The real returns on Ottoman debt were correspondingly low (1.6 per cent, compared with an anticipated return of 7.4 per cent).
The problem with ‘informal imperialism’ – investment in the absence of direct political control – was that financial control was harder to impose, so that the risk of default remained high. Between 1880 and 1914 nearly all the biggest defaults, apart from that of Turkey, were in Latin America (Argentina in 1890, Brazil in 1898 and 1914 and Mexico in 1910). As Table 16 makes clear, countries under British control – Australia, Canada and Egypt – offered overseas investors markedly higher real returns than independent states like Japan, Russia and Turkey. On average, Latin American states lay somewhere in between, though Mexico stands out because of its repeated defaults.
Table 16. Anticipated and real premiums on selected international bonds, 1850–1983
Definitions: premium – difference between rate of return on foreign bond and rate of return on UK or US (according to country where foreign bond was issued) long bond for equivalent holding period; ex ante – internal rate of return implied by the bond issue price and repayment terms; ex post – real realized rate of return deflated by consumer price index of lending country.
Source: Lindert and Morton, ‘How Sovereign Debt Has Worked’, tables II and III. Lindert and Morton’s sample consisted of 1,557 external bonds issued by the public sectors of ten major countries. They include bonds outstanding in 1850 and all those issued between 1850 and 1970.
Figure 28. Yield spreads over consols, 1870–1913
Source: Batley and Ferguson, ‘Event Risk’.
THE PARADOX OF CONVERGENCE, 1870–1914
From the 1870s until 1914 there was a marked convergence in the long-term interest rates of most major economies. Yield spreads between British consols and more or less equivalent French, German, Russian, Italian and American long-bonds all tended to fall. For example, Italian yields, which were close to double British yields in 1894, had fallen to just 54 basis points above them by 1907.92 Figure 28 presents monthly data for yield spreads relative to consols for a sample of seven countries for which monthly data are available. Although part of this convergence was due to the rise of consol yields from their all-time nadir of 2.25 in July 1896 to 3.6 per cent in July 1914, the main reason for convergence was the decline in yields on the bonds of the other great powers.
Economic historians have offered three distinct, though not mutually exclusive explanations for this phenomenon. One is simply the high level of integration of global capital markets. A number of studies have shown that there was an extraordinary – and as yet unmatched – disconnection between saving and investment in the period 1880–1914 because of international financial flows, falling transaction costs and unrestricted arbitrage.93 In fact, a comparison of prices for identical securities in different markets during seven financial crises between 1745 and 1907 suggests that financial integration may have been somewhat less in the early twentieth century than it had been in the mid-eighteenth century.94 However, these snapshots may be distorted by problems of market liquidity associated with crisis periods. Given the growth in volume of asset arbitrage after 187095 and the increased ease of comm
unications following the introduction and proliferation of the telegraph,96 a gradual process of international financial integration seems undeniable, albeit one that was punctuated by occasional and severe crises.
A second possible explanation for the convergence seen in Figure 28 lies in the realm of fiscal policy. According to one line of argument, interest rate differentials were related to debt/gross domestic product ratios: they can therefore be seen as ‘a broad measure of default risk’, though ‘countries had to plunge quite deep into debt before they started feeling the pain’ in the form of higher yields.97 Yet debt/GDP ratios tell us relatively little. Some of these countries had very high proportions of long-term debt, others had substantial short-term liabilities.98 Some countries (notably Russia) had substantial external debts; others (Britain and France in particular) held nearly all their debt domestically. Some denominated much of their debt in gold; others did not. In any case, debt/GDP ratios were unknown to contemporary investors since – as we saw in Chapter 4 – gross domestic product is a twentieth-century concept, and only a few attempts to estimate national wealth and income had been made in the period before the First World War.
Appendix D gives some of the measures with which late-nineteenth-century investors would have been more familiar. Here debt is related to government revenue and exports (the latter ratio being especially important to countries like those of Latin America or the Middle East with large proportions of debt in foreign hands and currency). In addition, debts have been adjusted to take account of the higher interest coupons on peripheral countries’ bonds, as well as state assets on the other side of the balance sheet (important in the case of countries that had financed their railway networks through government bond issues). In order to give an impression of the extent of nineteenth-century globalization, the table includes all the countries surveyed in Fenn’s Compendium of 1889, one of the most comprehensive manuals for investors in the later part of the century. The approach taken in the Compendium seems to have been typical of the period. There are methodological similarities between Fenn’s calculations and the debt/national wealth ratings devised by Michael Mulhall in the 1890s; while Crédit Lyonnais based its credit ratings on net debt service as a proportion of tax revenue, allowing for past episodes of default.99
The Cash Nexus: Money and Politics in Modern History, 1700-2000 Page 36