by Adam Tooze
As critics like John Maynard Keynes, the brilliant young economist advising the UK Treasury, had predicted, delivering the knock-out blow to Germany put Britain at the mercy of the United States. Lloyd George had willingly courted this risk, expecting America to understand its own interests in an Atlantic alliance. But as Keynes was to experience first hand in Washington in the summer of 1917, the reality of transatlantic partnership was less reassuring than the rhetoric of a democratic alliance might suggest. To Keynes it seemed that the Wilson administration positively relished the opportunity to reduce Britain to a state of ‘complete financial helplessness and dependence’.33 That dependence expressed itself at its most basic level in the monetary system. Before the war, the international gold standard had been anchored to the gold parity of the pound sterling. After 1914, though it could no longer be freely converted at home, sterling remained nominally attached to gold and in New York the exchanges continued to function. For the Entente Powers it was vital to maintain the value of their currencies against the dollar. They couldn’t credibly promise to repay their dollar debts if the lira, the rouble, the franc or sterling were depreciating violently. The dollar costs of debt service would become exorbitant. In January 1917, in a confidential memo for the Treasury, Keynes advised strongly against leaving the gold standard: ‘we have made a fetish of the gold standard. We have taken immense pride in it . . . To point out the depreciation of the German exchanges and the stability of our own has been our favourite form of propaganda.’34
Keynes, characteristically, hit upon the central point. The dependence of the Entente on the United States was not necessary. Like Germany, the Entente could have tried to fight the war without American resources. But this would have been a very different kind of war than that for which London, Paris and Petrograd had planned in early 1917. London’s decision to lead the Entente toward Wall Street was taken as part of the deliberate high-risk strategy, as part of an all-out effort to deliver the ‘knock-out’ blow. And it did serve to give the Entente an impressive material preponderance both on the battlefield and in terms of the material conditions of the home front. But once the decision to engage the US was adopted, once it was made into both a cornerstone of military strategy and of Entente propaganda, it created an immense dependence, and the Wilson administration both before and after American entry into the war was conscious of this. In the spring of 1917 Wilson’s Treasury Secretary (and son-in-law) William McAdoo made quite clear that he aimed to replace sterling with the dollar as the key reserve currency.35 As a first move, McAdoo proposed that no funds from congressionally approved Liberty Loans should be used to support either sterling or the franc. Nor should London be permitted to use such funds to repay overdrafts that it had contracted with J. P. Morgan during Wilson’s credit freeze over the winter of 1916–17. This put London under terrible pressure. First at the end of June, and then again at the end of July 1917, Britain came within hours of default.36 The near panic this caused in London and on Wall Street was enough to convince the Wilson administration that even if the dollar was to replace sterling in the long run, in the short term defending sterling was the cheapest way to prop up the Entente war effort. But this guarantee was limited to the duration of the war. When hostilities ended, the Entente would be left to its fate. The US dollar would emerge as the only global currency still securely based on gold.
The fact that American support was limited to the bilateral dollar-sterling rate was significant in light of monetary relations within the British Empire. The empire had two lopsided monetary pillars, the first being sterling based on gold supplied in large part from South Africa. The second was the Indian rupee based on an uneasy silver-currency standard. The war put this structure under extreme pressure. Britain’s imports from the Dominions and India surged, whilst its exports to the empire were throttled to a bare minimum. The empire accumulated large surplus claims on Britain, but given its desperate need for dollars and gold, London could not permit the empire to indulge in an import boom from third markets, such as the US. Within days of the outbreak of war, London declared a monopoly on the output of South Africa’s gold mines, setting an artificially low official price and raking in exorbitant fees for shipping and insurance. South African banks attempting to sell gold directly to the US at higher market prices were subject to sanctions and a vicious propaganda campaign denouncing them for collaboration with the enemy.37 Despite protests from the mining corporations who were in effect being forced to provide a subsidy to the British war effort, the price was held until the end of the war. The result was to concentrate one of the world’s main supplies of gold in London, but also to provoke bitter nationalist protests. In the Transvaal mining region vociferous Boer activists demanded that South Africa must take full control of its own gold, establishing refineries and its own mint.
Whereas in South Africa attention focused on a single key commodity produced by gigantic, British-owned mining corporations, employing a minority workforce of white miners, in India, wartime financial relations were potentially even more explosive, involving as they did the relations between the British and a population of 240 million people largely dependent on agriculture for their subsistence. The ‘economic drain’ on India had long been a staple of nationalist argument.38 Whatever the merits of the case prior to 1914, once the war began, ‘the drain’ took on a manifest reality. From the autumn of 1915 the balance of trade shifted decisively in India’s favour. Under normal circumstances this would have triggered either expanded Indian imports or an inflow of precious metals. But instead, to prevent India’s purchasing power from spilling over into a huge surge in ‘unnecessary’ imports, wartime controls were extended to the subcontinent.39 Held in bank accounts in London, India’s export earnings were invested in British war bonds. In effect, India was enrolled in an involuntary war-saving programme, a commitment made all the more painful because the government of India was simultaneously slashing spending on long-promised investments such as primary education to make room for war costs.40
In early 1916 the Indian currency was officially uncoupled from silver. Henceforth, the backing for the rupee would be the British government bonds held in London in India’s name. On the assumption that sterling retained its pre-war value, these bonds would be redeemable after the war for bullion or goods. But, in the likely event of a post-war devaluation, India would suffer a commensurate loss. In the meantime, India was awash with currency no longer backed by any metallic equivalent. Even at the best of times, Indian peasants were extremely reluctant to hold paper currency. With the risk of inflation becoming more and more obvious, the remaining silver stocks disappeared from the market. This in turn made it harder to sustain the fiction that the flood of paper rupees would eventually be redeemable in specie. As a countermeasure, in April 1916 the government of India began feeding silver purchased in the United States into circulation.41 But, given its desperate shortage of dollars, this could never satisfy demand. Nor did America’s entry into the war bring any immediate relief. Instead, in September 1917, Washington insisted that if India was providing Britain with deliveries on credit, then the same privilege must be extended to the US as well. The United States extracted a rupee credit equivalent to $10.5 million from India.
By early 1918 the Indian currency system was close to collapse. In Bombay political discussion of the Montagu-Chelmsford reforms was overshadowed by tumultuous scenes on the exchanges as merchants scrambled to cash their rupee notes for the dwindling stock of silver. Given London’s precarious position, only the United States had the resources to underwrite the monetary system of the Raj. On 21 March Washington announced that it would throw open for sale the enormous silver reserves of the US. Under the Pittman Act the sale of 350 million ounces of silver was approved, at the fixed price of one dollar per ounce. The government of India was authorized to use its funds in London to replenish its silver stocks from the American official reserves.42 In effect India was uncoupled from sterling and moved to
a silver-dollar basis, with the rupee valued at approximately a third of an ounce of silver, or 35.5 cents. Against sterling the rupee promptly appreciated from 16 pence per rupee to 18 pence. This devaluation of sterling raised the cost of imports to Britain. But the political relief was huge. As the Indian currency controller warned, a failure by London to meet the demand for silver would have been a greater blow to the Raj than a military defeat, or even a ‘German landing in Norfolk’.43
Table 4. The Wartime Dislocation of the Global Price System: Wholesale Prices (1913=100)
II
World War I ratified the emergence of the US as the dominant force in the world economy. The rivalrous talk in London and Washington could give the impression that the issue at stake was the question of how America would succeed to Britain’s position of pre-eminence. But that seriously understated the novelty of the situation created by the war. In its pomp Victorian Britain had never commanded the kind of leverage over Prussia, or Napoleon III’s France, or Alexander III’s Russia, that Washington was accumulating. In their struggle to defeat Germany, the Entente entered into an unprecedented period of dependence on the United States. This new asymmetrical financial geometry signalled the end to the great-power competition that had defined the age of imperialism. It did so in a double sense. On the one hand, the Entente’s transatlantic war effort defeated Germany. But at the same time it raised the US to a position of unprecedented dominance, not over its Caribbean satrapies or the Philippines, but over Britain, France and Italy, the great powers of Europe. In its basic outline this was exactly the kind of unilateral power to which Woodrow Wilson had aspired with his strategy of ‘peace without victory’. Whether it would actually give Washington the leverage that he hoped for would depend on three questions: Would the democracies of Europe cooperate in their submission to the financial demands of their new creditor? Would Washington be able to block the efforts of the European Powers to enrol the United States in their own, more multilateral vision of a new international economic order? And would America’s own institutions prove adequate to the challenge of an entirely new kind of financial leadership?
That there would be need for such leadership was by 1918 painfully evident. Despite American support, the underlying weakness of the British, French and Italian currencies was unmistakable. And their anxious gyrations were superimposed on a more basic global trend: inflation. The post-war hyperinflation that wracked the Weimar Republic in 1923 is the stuff of legend. But it was not a unique experience. In the aftermath of the war, Poland, Austria and Russia all suffered devastating hyperinflations. And it was not until 1920 that the trajectory of these countries diverged fundamentally from that of the other combatants. Between 1914 and 1920, inflation swept the world. In Sierra Leone the price of a cup of rice rose fivefold.44 In Harare the real wages of African workers halved.45 In Egypt, as in India, the metallic basis of the currency was replaced by the dubious backing of British government debt. The money supply promptly doubled, leading to a disastrous surge in the urban cost of living (Table 4).46
Price changes on this scale triggered bitter social conflicts over shares of purchasing power and wealth. Producers of goods that were in high demand and those who could set their own price generally did well out of the war. On the other hand purchasers with sufficient clout, such as the British Empire, could fix the market to their advantage. Britain not only set the price for South African gold. It also rigged the price of Egyptian cotton.47 In all of the combatant economies, indispensable war workers were able to extract premium wages. But this, in turn, increased the incentive for employers and the war-planning authorities to dilute the male workforce with underpaid female labour. As inflation accelerated, battles over income shares expanded into a generalized war of all against all. Most dangerously, peasant farmers became increasingly unwilling to exchange their crops for devalued currency. Only the promise of industrial goods would coax them out of a retreat into self-sufficiency. In 1917 it was riots on the bread lines that toppled the Tsarist monarchy. By 1918 much of central Europe was starving and the entire economy of the Indian Ocean and Pacific was facing a dramatic rice crisis.48 In Japan, just as it launched its controversial intervention in Siberia in August 1918, the government of Prime Minister Terauchi Masatake was toppled by an extraordinary wave of rice riots that swept from fishing villages to the industrial towns of the coast and from there to Tokyo itself.49
The ultimate driver of this inflationary wave was monetary expansion originating at the heart of the global monetary system in Europe and the US. As war expenditure surged, in none of the combatant countries did taxes keep up. The state skimmed off purchasing power by issuing government bonds repayable long after the end of the war. But much surplus purchasing power remained in circulation. Furthermore, a large part of the bonds were purchased not by savers but by banks. Rather than immobilizing household funds, the bonds provided the banks with a safe investment that could be resold for cash to the central bank – the Bank of England, Bank of France or Reichsbank. Like a cash deposit, the bonds therefore served as the basis for a pyramid of credit-creation. The central banks were transformed into inflationary pumps. The entire sterling zone of the British Empire was swept up in the inflation issuing from London, the Treasury and the Bank of England. Through these same mechanisms, rapid inflation came even to the heart of the new structure of financial power, the United States.
The story of American war finance was told by boosters of Wilsonianism as the story of the Liberty Bond.50 Before the war no more than 500,000 wealthy Americans had invested regularly in government debt. By the end of the war Treasury Secretary Russell Leffingwell claimed that 20 million American citizens had signed for Liberty Bonds and perhaps as many as 2 million Americans had joined the volunteer sales force that reached virtually every community in the country. Over $30 billion were raised. This huge popular mobilization was presented by the Wilson administration as a fundamental advance in democracy and a break with the bad old days of Wall Street domination. In fact, it was in many cases a coercive mobilization with huge pressure being exerted, particularly on recent immigrants, to prove themselves 100 per cent American. Stiff prison sentences were handed out for anyone daring even to question the official Liberty Bond propaganda. If it had been matched by an equivalent amount of private saving, the Liberty Bonds would have served as a solid, non-inflationary foundation for the entire Allied war effort. This was certainly the rhetoric that would surround the loans in later years. Millions of ordinary Americans had sunk their hard-earned savings into the Allied war effort and must therefore be repaid. But though the Liberty Bonds certainly bulked large in the popular imagination and were undeniably vital to the collective war effort, their relationship to real saving was far from straightforward. Saving by American households and businesses actually slumped in 1918. In large part, therefore, the flow of funds to the Federal government was provided by an increase in bank credit. Desperate as they were to prevent any dislocation in America’s fragile banking system, the Treasury and the Fed underwrote this monetary expansion. Reserve requirements were loosened. In advance of the issue of each tranche of Liberty Bonds the Treasury anticipated the proceeds by releasing huge volumes of short-term Treasury certificates directly to the banks. These were supposed to be redeemed out of the dollars raised from the sale of the Liberty Bonds. But in practice vast portfolios of certificates remained with the banks, putting the Treasury under constant pressure to refinance (Table 5).51
With government expenditure surging, and private demand not substantially contained, compensation might have come, as it was to do in World War II, through an increase in actual economic activity. The expanded flow of purchasing power might then have been matched by additional goods and services. In the first years of the war the procurement orders of the Entente had had this effect on the American economy, driving up employment and output.52 But in 1916 productive expansion reached its limit. Measured in prices of 1914, Amer
ican GDP rose fractionally over the following two years from $41.3 billion in 1916 to only $42.9 billion in 1918, before relapsing to $41 billion in 1919.53 Despite the propagandistic bluster, there was no substantial increase in either output or productivity. With an expanding flow of demand competing for a static volume of output, the result was inevitable. The war was paid for through an inflation tax. Whereas real output barely increased, between 1916 and 1920 nominal national income surged from $43.6 billion to $82.8 billion. Prices doubled. In 1914 Ford had caused a worldwide sensation with his $5 per-day wage. By the late summer of 1917 that was no more than a bare minimum. As the cost of living surged, real wages lagged behind.54 Between 1914 and 1916 the profits earned by American export industry were nothing short of phenomenal.55 As labour unions struggled to maintain their members’ real earnings, they unleashed an unprecedented wave of labour disputes that shook America between 1917 and 1919.