The War of the World: History's Age of Hatred

by Niall Ferguson

  If any social group had a strong interest in anticipating the approach of a world war, it was investors and the financiers who served their needs in the City of London, the biggest international financial market in the pre-war world. The reason is obvious: they had a great deal to lose in the event of such a war. In 1899 the Warsaw financier Ivan Bloch estimated that ‘the immediate consequence of war would be to send [the price of] securities all round down from 25 to 50 per cent’. The journalist Norman Angell made similar points about the negative financial consequences of great-power conflict in his best-selling tract of 1910, ‘The Great Illusion’. Both authors expressed the hope that this consideration might make a major war less likely, if not impossible. But investors, especially investors with holdings of bonds issued by the great powers, could scarcely afford to take this for granted. We would therefore expect any event that made such a war seem more likely to have had a detectable effect on investor sentiment. Yet it would seem that the City, including some of its best-informed financiers, discerned the imminence of world war only at a very late stage indeed.

  In 1914 N. M. Rothschild & Sons was still the pre-eminent firm in the City. Closely associated with their cousins in Paris and Vienna, the London Rothschilds had dominated the bond market for very nearly a century, since Nathan Mayer Rothschild had made the family’s fortunes before and after the Battle of Waterloo. Between them the Rothschild houses had capital in excess of £35 million on the eve of the First World War, all of it family money; it was the job of the partners to manage this huge portfolio. A large part of it they held in the form of European government bonds, the most secure form of investment and also the kind of security the Rothschilds knew best, since they had long been the principal underwriters for new bond issues on the London market. They, more than anyone, stood to lose in the event of a European war, not least because such a war would almost certainly divide the three houses, pitting Paris and perhaps also London against Vienna. Yet the outbreak of war caught them almost entirely by surprise. On July 22, 1914 Lord Rothschild told his relatives in Paris that he ‘rather fanc[ied] the well founded belief in influential quarters that unless Russia backed up Servia the latter will eat humble pie and that the inclination in Russia is to remain quiet, circumstances there not favouring a forward movement’. The following day he wrote that he expected ‘that the various matters in dispute will be arranged without appeal to arms’. Before the details of the Austrian ultimatum to Serbia were known, he anticipated that the Serbs would ‘give every satisfaction’. On July 27 he expressed ‘the universal opinion that Austria was quite justified in the demands she made on Servia and it would ill-become the great Powers if by a hasty and ill-conceived action they did anything which might be viewed as condoning a brutal murder’. He was confident that the British government would leave ‘no stone… unturned in the attempts which will be made to preserve the peace of Europe’. ‘It is very difficult to express any very positive opinion,’ he told his French relatives on July 29, ‘but I think I may say we believe [French opinion]… to be wrong… in attributing sinister motives and underhand dealings to the German Emperor[;] he is bound by certain treaties and engagements to come to the assistance of Austria if she is attacked by Russia but that is the last thing he wishes to do.’ He and the Tsar were ‘corresponding directly over the wires in the interests of peace’; the German government sincerely wished any war to be ‘localised’. As late as July 31, Rothschild continued to give credence to ‘rumours in the City that the German Emperor [was] using all of his influence at both St Petersburg & Vienna to find a solution which would not be distasteful either to Austria or to Russia’. Only at this, the eleventh hour, did he show signs of grasping the scale of what was happening.

  Rothschild was by no means exceptionally slow on the uptake. On July 22 – more than three weeks after the assassination at Sarajevo – The Times published what seems to have been the first English-language allusion to the possibility that the crisis in the Balkans might have negative financial consequences. The report appeared on page 19 and read as follows:

  FAULT LINES

  STOCK EXCHANGE DEPRESSED BY FOREIGN POLITICAL NEWS

  LATE RALLY IN AMERICANS

  Stock markets at the opening were entirely overshadowed by the news that the relations between Austria-Hungary and Servia are daily growing more strained… Owing to the increasing gravity of the situation in the Near East the attention of members [of the Stock Exchange] has for the moment appeared to be diverted from the Ulster crisis… there being a general disinclination to increase commitments in view of the obscurity of the outlook both at home and abroad.

  In its July 24 edition, however, The Economist was more concerned about ‘the continual suspense over Ulster’ than about events in the Balkans. The same magazine’s August 1 edition made it clear just how surprised the City was by the events of the intervening week:

  The financial world has been staggering under a series of blows such as the delicate system of international credit has never before witnessed, or even imagined… Nothing so widespread and so world-wide has ever been known before. Nothing… could have testified more clearly to the impossibility of running modern civilisation and war together than this… collapse of prices, produced not by the actual outbreak of a small war, but by fear of a war between some of the Great Powers of Europe.

  The key phrase here is ‘fear of a war’. Although Austria had declared war on Serbia on July 28, even at this late stage it was still far from certain that the other great powers would join in. As late as August 1 – by which time Russia had begun general mobilization – the headline on the front page of the New York Times was the wildly optimistic: CZAR, KAISER AND KING MAY YET ARRANGE PEACE.

  Financial market data – specifically, movements in the prices of government bonds – strongly reinforce the impression that the war came as a surprise to the people who had the biggest incentive to anticipate it. The five generally acknowledged great powers – Britain, France, Germany, Russia and Austria-Hungary – had all issued very large quantities of interest-bearing bonds to finance wars in the past and all could be relied upon to do so again in the event of a major European conflict. In 1905 bonds issued by the five powers accounted for nearly 60 per cent of all sovereign fixed-income securities quoted in London. Bonds issued by France, Russia, Germany and Austria accounted for 39 per cent of the total, or 49 per cent of all foreign sovereign debt. It is the regularly quoted market interest rates on these bonds – the yields, to use the technical term – that allow us to infer changes in investors’ expectations of war in the years up to and including 1914.

  Political events were especially important to investors before 1914 because news about them was more readily and regularly available than were detailed economic data. Modern investors tend to look at a wide variety of economic indicators such as budget deficits, short-term interest rates, actual and forecast inflation rates and growth rates of gross domestic product. They are inundated on a daily basis with information about these and a host of other measures of fiscal, monetary and macroeconomic performance. In the past, however, there were fewer economic data on which to base judgements about default risk, future inflation and growth. Prior to the First World War, investors in the major European economies had fairly good and regular information about certain commodity prices, gold reserves, interest rates and exchange rates, but fiscal data apart from annual budgets were scanty, and there were no regular or reliable figures for national output or income. In non-parliamentary monarchies, even annual budgets were not always available or, if they were published, could not be trusted. Instead, investors tended to infer future changes in fiscal and monetary policy from political events, which were regularly reported in private correspondence, in newspapers and by telegraph agencies. Among the most influential bases for their inferences were three assumptions:

  that any war would disrupt trade and hence lower tax revenues for all governments;

  that direct involvement in war would
increase a state’s expenditure as well as reducing its tax revenues, leading to substantial new borrowings; and

  that the impact of war on the private sector would make it hard for monetary authorities in combatant countries to maintain the convertibility of paper banknotes into gold, thereby increasing the risk of inflation.

  On that basis, any event that seemed to increase the probability of war should have had a discernible impact on the bond market. War meant new bond issues, in other words an increase in the supply of bonds, and hence a reduction in the price of existing bonds. War also meant an increase in the supply of paper money, and hence a decrease in the purchasing power of the currencies in which most bonds were denominated. A rational investor who anticipated a major war would sell bonds in anticipation of these effects. If financial markets saw the war of 1914–18 coming, we should expect to see declines in bond prices or rises in bond yields (since the yield is essentially the interest paid on a bond divided by its market price).

  Far from registering the approach of a world war, however, most financial market indicators in the years leading up to July 1914 implied a decline in the risks to investors. Political events, which had caused sizeable movements in bond prices from the 1840s to the 1870s, seemed to matter less and less in the subsequent two decades. Volatility in the international bond market also declined quite markedly. Bond prices did fall sharply once investors realized that a great-power war was a real possibility, but the striking thing is that this did not happen until the last week of July 1914 – to be precise, in the week after the publication of the Austrian ultimatum to Serbia, which demanded cooperation with an Austrian inquiry into the Sarajevo assassinations. That ultimatum was delivered on July 23. Between July 22 and July 30 (the last day when quotations were published), consol prices fell by 7 per cent, French rentes by just under 6 per cent and German bonds by 4 per cent. The declines were roughly twice as large for Austrian and Russian bonds. Even so, these were not by any means unprecedented market movements. The explanation is simple: when the London market closed on July 31 the magnitude of the crisis had still not yet become fully apparent. Had the market remained open, prices of all securities would have fallen much further. It was not until July 31 that Russia, after three days of indecision, began general mobilization and the German government issued its ultimatums to St Petersburg and Paris. The Germans declared war on Russia only on August 1; the declaration of war on France came two days later. Britain did not enter the fray until the 4th – a decision that was opposed by both the Rothschilds and the editors of The Economist. In the eyes of these strongly interested parties, then, what happened between July 22 and July 30 was essentially a sharp rise in the perceived probability of a great-power war on the continent; Armageddon was still not seen as a certainty, even when the markets were forced to close.

  Table 3.1: Bond prices of the European great powers, July–December 1914

  As the probability of war suddenly rose, the financial crisis long ago foreseen by Bloch, Angell and others unfolded with terrible swiftness. What happened was a classic case of international financial contagion. The Vienna and Budapest markets, which had been sliding for more than a week, were closed on Monday, July 27, St Petersburg followed two days later, and by Thursday The Economist regarded the Berlin and Paris bourses as shut in all but name. The closure of the continental stock markets caused a twofold crisis in London. First, foreigners who had drawn commercial bills on London found it much harder to make remittances; those British banks which had accepted foreign bills suddenly faced a general default as the bills fell due. At the same time, there were large withdrawals of continental funds on deposit with London banks and sales of foreign-held securities. As Lord Rothschild nervously reported to his French cousins on July 27, ‘All the foreign Banks and particularly the German ones took a very large amount of money out of the Stock Exchange to-day and… the markets were at one time quite demoralized, a good many weak speculators selling à nil prix.’ London became, as The Economist put it, ‘a dumping ground for liquidation for the whole Continent of Europe’. On July 29, with the clearing banks declining to accommodate their hard-pressed Stock Exchange clients, trading effectively ceased and the first firms began to fail. The next day the news broke that the well-known stockbrokers Derenburg & Co. had been ‘hammered’ (declared bankrupt); this, coupled with the Bank of England’s decision to raise its discount rate from 3 to 5 per cent, deepened the gloom. On the morning of the 31st came what The Economist called the ‘final thunderclap’ – the closure of the Stock Exchange, followed by the Bank of England’s decision to raise the discount rate again, to 8 per cent. There is no need to detail here the subsequent steps taken by the authorities to avert a complete financial collapse. The crucial point is that by July 31 the crisis had closed down the London stock market, and it stayed closed until January 4, 1915. There could be no better testimony to the size of the financial shock caused by the outbreak of war.

  The closure of the Stock Exchange could only disguise the crisis that had been unleashed; it could not prevent it. The isolated bond prices recorded for the period when the market was closed (based on significant transactions conducted outside the usual channels) make this clear. The price quoted for Austrian bonds on December 19 was 23 per cent below the pre-crisis level on July 22. For French rentes the differential was 13 per cent, for British consols and for Russian bonds (surprisingly) just 9 per cent. This was merely the end of the beginning, however. In the course of the war, large new issues of bonds as well as money creation through the discounting of treasury bills led – just as the experts had predicted – to sustained rises in the yields of all the combatants’ bonds. These movements would have been significantly larger had it not been for the various controls imposed on the capital markets of the combatant countries, which made it difficult for investors to reduce their exposure to pre-war great-power bonds, as well as by systematic central bank interventions to maintain bond prices. Even so, they were substantial. From peak to trough, consol prices declined 44 per cent between 1914 and 1920. The figures for French rentes were similar (a 40 per cent price drop). Moreover, Britain and France were the two great powers that emerged on the winning side of the war. The other three all suffered defeat and revolution. The Bolshevik government defaulted outright on the Russian debt, while the post-revolutionary governments in Germany and Austria reduced their real debt burdens drastically through hyperinflation. For all save the holders of consols, who could reasonably hope that their government would restore the value of their investments when the war was over (as had happened after all Britain’s wars since the reign of George I), these outcomes were even worse than the most pessimistic pre-war commentators had foreseen. The impact of war on the Rothschilds was devastating. In 1914 alone their losses – close to £1.5 million – were the largest in the firm’s history. Between 1913 and 1918 the London partners’ capital was reduced by more than half. The fact that the financial markets do not seem to have considered such a scenario until the last days of July 1914 surely tells us something important about the origins of the First World War. It seems as if, in the words of The Economist, the City only saw ‘the meaning of war’ on July 31 – ‘in a flash’.

  The story on Wall Street was the same – the New York Times spoke of a ‘conflagration’ – though the crisis took a different form. There it was the desire of hard-pressed Europeans to liquidate their holdings of American railroad securities (20 per cent of which were in foreign hands) that threatened to unleash a financial crisis even more severe than the last great ‘panic’ of 1907. Interestingly, there had in fact been significant outflows of gold from New York throughout the summer of 1914, apparently caused by Russian efforts to build up reserves in St Petersburg. But the withdrawals reached a peak after the news of the Austrian ultimatum to Serbia. Sterling soared against the dollar as investors sought desperately to remit funds back to Europe; those who would normally have engaged in arbitrage to exploit this weakening of the dollar were deterred
by the wartime leap in insurance premiums for gold shipments. Naturally, European sales dented US stock prices, which fell by 3.5 per cent on the news of the Austrian declaration of war five days later. As in London – indeed, on the same day – the decision was taken, with the strong encouragement of the Treasury Secretary William McAdoo, to close the Stock Exchange. It is true that unofficial quotations on the outdoor New Street market indicate that the market might not have collapsed completely (by the end of October they were down a further 9 per cent). But that was only because the unofficial market was too small to allow Europeans to realize all that they wanted to sell and because McAdoo was simultaneously working to inject emergency banknotes into the US banking system to avoid a default by the City of New York on its sizeable foreign debt, and to encourage, through the creation of a Bureau of War Risk Insurance, the shipment of American exports to Europe to get gold flowing back across the Atlantic. In the absence of these emergency measures, Wall Street would surely have witnessed a wave of bank failures even bigger than had been seen seven years before.