To Arms

by Hew Strachan

  The Treasury reported on 15 May 1914. Already the beginnings of the run on gold could be detected. Demand for short-term securities in London grew throughout May and June, as an economic downturn created pressure to have assets liquid and available. From 24 July, after the Austrian ultimatum to Serbia, the continental powers called in their assets via London. Foreign capital applications in London totalled over £150 million in 1914, almost all of them before August: France alone withdrew £1,358,000 in the last week of July. Selling became so general as to threaten a collapse in the price of securities. Between 18 July and 1 August Russian 4 per-cent government bonds fell 8.7 per cent, French 3 per-cent bonds 7.8 per-cent, and German 3 per-cent bonds 4 per cent.19 The pressure on London increased as stock exchanges elsewhere closed, beginning with Vienna on 25 July. On 30 July only London, Paris, and New York were functioning, and on 31 July Paris announced it was postponing settlement for a month. At 10 a.m. on the same day, for the first time in its history, the London stock exchange closed its doors.

  The problem for sterling was London’s inability to meet new demands for capital. Most foreign balances were already committed to current trade. The loss of business from the continent meant that new funds were not forthcoming. Government-imposed moratoriums left foreign debts unpaid; of £350 million outstanding in bills of exchange, £120 million was owed either by the Central Powers or by Russia, and was therefore unlikely to be recovered even when the moratoriums were lifted. All foreign exchange rates, except France’s, moved in favour of London, increasing the reluctance to settle debts. Shipping had all but halted. Payments in gold were suspended by the Russian state bank on 27 July; the other central banks followed suit early in August.20 Catastrophe confronted the London commercial banks. Representatives of twenty-one merchant banks met on 5 August and reckoned that over £60 million in acceptances was owed them by enemy firms, but that their own capital was only £20 million.21 The practice of acceptance houses was to rediscount bills when they neared maturity with the clearing banks. The clearing banks’ room for manoeuvre was restricted by the closure of the stock exchanges, and by their own refusal to extend credit.

  On 30 July the Bank of England advanced £14 million to the discount market and a comparable sum to the banks.22 But having gone some way to fulfilling its function as the lender of last resort, it then had to protect its own reserves in its capacity as a central bank. It raised the interest rate from 3 per cent to 4 per cent on 30 July, to 8 per cent on 31 July, and to 10 per cent on 1 August. The rate was excessive. The problems on the external market were generated less by the policy of the Bank than by the hoarding instincts of the central banks of other nations. Foreign firms trying to remit to London were being prevented by their governments from doing so. Nonetheless, the last week of July showed a net influx of gold from abroad of £1.4 million. At the same time the Bank’s holdings of securities and stocks recovered, but its gold reserves fell from £29.3 million to under £10 million. The pressure was now more internal than external.

  The fall in the stock exchanges had wiped out the margins on securities used by stockbrokers as collateral for bank advances. The banks had called in their loans, so forcing further selling of shares and further reductions in the margins on collateral. The closure of the stock exchange had then rendered any remaining shares non-negotiable. The bill brokers, under pressure from the clearing banks, rediscounted bills with the Bank of England, so increasing the Bank’s deposits but reducing its gold. The banks, anticipating the storm from the acceptance houses, also drew on the Bank’s gold. Simultaneously, however, they refused to give the public payments in gold, and insisted they accept the smallest-denomination note, £5, which was too large for normal use. The banks were convinced that their customers wanted to hoard. Their customers were more pragmatic: they wanted cash to cover the impending August bank holiday weekend. They therefore took their notes to the Bank of England to exchange them for coin. Keynes, a severe critic of the clearing banks’ instincts for individual self-preservation, observed the collective consequence of their actions: ‘our system was endangered, not by the public running on the banks, but by the banks running on the Bank of England.’23

  Not only the clearing banks but also the Treasury—with its refusal to engage in pre-war planning and its lifting of the Bank rate to 10 per cent—had deepened the crisis. All sides now gave themselves breathing-space by adding three extra bank holidays, so that business would not resume until Friday 7 August. The clearing banks had asked the Bank of England to implement its earlier recommendations for creating emergency currency; indeed, their hope that their request would be met was an additional factor in their holding gold. Told on 2 August that their suggestion was still not acceptable, they made four demands—that emergency currency be issued nonetheless, that the 1844 Bank act be suspended, that specie payments be halted, and that there should be a general moratorium. All of these proposals were debated at a conference convened by the Treasury on 4 August.

  The 1844 Bank act was suspended, but it was not (as the banks had assumed it would be) a necessary corollary of the issue of additional notes. The emergency currency (£1 and 10 shilling notes) was issued by the Treasury and not by the Bank of England. This was to ensure its acceptability in Scotland and Ireland. A maximum issue of £225 million (20 per cent of the banks’ liabilities) was authorized at the Bank rate of interest. The banks rightly argued that the rate should be reduced. Externally it was not helping as the problems were not of Britain’s making, and domestically it was creating panic and depressing business. The Bank of England’s commercial concerns helped it accept the clearing banks’ case; if the differential between the Bank’s rate and that of the clearing banks were too great, then the former’s creditors would shift their business to the latter, so enabling the clearing banks to profit from the crisis.24 The interest rate was reduced to 5 per cent by 8 August. The final issue was convertibility. The banks had assumed that suspension of the Bank act and the issue of emergency currency would oblige the Bank of England to abandon the gold standard.

  On 3 August J. M. Keynes, not yet employed by the Treasury but consulted by it, hammered home two vital points. The first was the difference between the internal demand for gold and the external demand. The purpose of the Treasury currency notes was to meet the former—and, although strictly speaking they were convertible, this was not an option likely to be exercised. By easing the domestic calls on gold, the Bank had more gold available for exchange purposes. His second major message, therefore, was the vital importance of continued convertibility. As he reiterated throughout the war, it was ‘useless to accumulate gold reserves in times of peace unless it is intended to utilise them in time of danger’. By maintaining convertibility, Britain would sustain its purchasing power in international markets and would retain foreign confidence and therefore foreign balances in London.25

  At the outset of the conference Lloyd George, the chancellor of the exchequer, had been sufficiently in the thrall of the clearing banks to have been considering the cessation of convertibility. But, as Keynes and the Treasury stressed, the gold which the crisis had siphoned off from the Bank of England had not gone abroad; it had flowed to the clearing banks because of the latter’s squeezing of credit and their determination to seize the opportunity which the war offered of fulfilling their pre-war agenda. The only foreign power which could demand gold from Britain was France, a British creditor in July 1914;in general terms the world was Britain’s debtor, and London was therefore well able to sustain its overseas purchases. Lloyd George was convinced. Britain stayed on the gold standard. On 6 August a royal proclamation postponing payments on bills of exchange for a month was confirmed by act of parliament. When the banks reopened on 7 August the domestic crisis had passed.

  But if the maintenance of convertibility was to have any meaning, it was the exchange market—not domestic confidence—which required reassurance. On 13 August the Bank of England agreed to discount all approved bills accepted before
4 August 1914. The government was to guarantee the Bank against any eventual loss. However, no protection was accorded the acceptance houses, which remained reluctant to undertake new business. Therefore, on 5 September the Bank announced that it would advance funds at 2 per cent above Bank rate to enable the repayment of pre-moratorium bills on maturity; these advances would not be reclaimed until one year after the war’s end. By the end of November most of the £120 million’s worth of bills discounted by the Bank under its arrangements of 13 August had been redeemed.

  The government’s handling of the crisis reflected the view that the key to economic management lay in finance, not in industry. Having initially treated the crisis like any other, with the raising of interest rates and the suspension of the Bank act, it had then stepped up a gear to more direct interventionism. Furthermore, it had accomplished this at the urgent behest of that stronghold of free-trade principles, the City of London. Neither the Bank of England nor the clearing banks had cause for complaint. The arrangements for pre-moratorium bills gave the former good business without major risk; the moratorium protected the latter, sandwiched between the absence of overseas remittances and the persistence of domestic demands for payments. One effect, therefore, was to redistribute the pressure generated by the international crisis away from the City to the manufacturers and small traders of Britain. They found themselves subject to a moratorium which starved them of cash but which still required them to pay wages. The government exhorted them to maintain full employment while extending the moratorium for two further months. The fact that the latter was not lifted until 4 November reflected the sway of finance in governmental calculations. The fact that the economic life of Britain continued nonetheless demonstrated the banks’ increasingly relaxed attitude to the formal protection which it provided.26

  Critics of the government said that it had put itself too much in the hands of the banks. A moratorium on past acceptances and a guarantee of new ones, leaving the banks to hold the debts themselves, would have been sufficient. The measures that were adopted were inflationary. The bills rediscounted by the Bank appeared as ‘other deposits’ and securities in the Bank’s accounts, and thus by a bookkeeping transaction could be the basis for advancing fresh credit. But even if the banks were rewarded with an injection of cash, the resumption of business proved sluggish. Overseas trade had fallen. The stock exchange did not reopen until 4 January 1915, and when it did the Treasury— with a view to giving the government first call on available capital—had to approve all new issues. Between 1915 and 1918 new overseas issues totalled £142 million, as against £159 million in 1914 alone. A merchant bank like Schröders, which had been heavily reliant on German business, limped along for the rest of the war. The Bank of England’s arrangements for pre-moratorium bills did not cover all their advances to enemy clients, and their acceptances in 1918 were valued at £1.3 million, as against £11.7 million in 1913. Schröders returned losses in every year until 1919.27

  The key outcome of the 1914 financial crisis was that Britain remained on the gold standard. From their low of £9,966,000, the Bank of England’s gold reserves reached £26,352,000 by the end of August, and £51,804,000 by the end of the year. Freed of the obligation to issue its own notes by the Treasury, and drawing in gold from the clearing banks, its reserves reached 34 per cent of its deposits by 18 November 1914. On the same date the Bank’s issue of gold coin and bullion, which had fallen to £26,041,000 on 5 August, peaked at £72,018,000. These were highs not to be repeated for most of the war; for much of the time, and continuously after June 1916, the proportion of reserves to deposits hovered at under 20 per cent, and not until October 1918 did the issue of gold coin again reach its November 1914 figure. But over the war as a whole the gold reserves of Britain increased by 109 per cent, and by 210 per cent when the currency note reserve was included.28

  This achievement was set against a decline in the world’s production of gold. Russian output fell from 146,470 pounds (weight) in 1914 to 66,960 pounds in 1916—the victim of a loss of labour, increased production costs, and transport problems. Payments to the producers, which had been fixed at a profit of 30 per cent in November 1915, were increased to a 45 per-cent profit in November 1916, but with negligible results on output.29

  Output in the British empire, which reached almost £60 million in 1916, fell thereafter.30 Australia imposed an embargo on the export of gold in 1915; designed to ensure sufficient cover for the commonwealth’s expanding note issue (by 1918 the note issue had risen from £9.5 million to £52.5 million, but the gold reserve had only fallen from 42.9 per cent to 33.6 per cent), the embargo depressed the price of Australian gold in international terms. Australia’s output, which had totalled £8.7 million in value in 1914, fell to just over £5 million in the last year of the war.31 But more important than any decision in Australia was the Bank of England’s fixing of the gold price. Two-thirds of Britain’s imperial gold came from South Africa. On 14 August 1914 the Bank of England secured an exclusive agreement with the mining companies of the Union, which fixed the official rate of gold at £3.17s. 9d. per standard ounce. Given the wartime problems of freight and insurance, the Bank’s terms were attractive as 97 per cent of the purchase price would be advanced before shipment. Similar arrangements were concluded with Australia. The gold could therefore remain in the Dominions without incurring the risk of loss at sea, and the advances made by London could go towards the issue of Dominion notes to fund the imperial war effort. But as mining costs rose, so the companies’ profits fell. Britain was able to buy gold at a fixed rate and sell it on to neutrals at the market price. The quantity of gold mined fell in 1917 and again in 1918. By then relations between the mines and London were fraught.32

  Initially, a further source of gold was the United States. The outbreak of the war coincided with the period before the autumn sales of corn and cotton, when America was normally in debt to London. Domestic depositors, unable to export their produce, withdrew cash from branch banks, which in turn— fearing a run—drew from the reserve city and central banks. As other stock exchanges across the world closed, dealing concentrated on New York. In the week before its closure on 31 July New York’s sales of securities increased sixfold. By 8 August 1914 European withdrawals had reduced the gold reserves of the New York banks by $43 million. By the end of the year short-term debts to the tune of $500 million had been called in by the belligerent powers, and gold exports had totalled almost $105 million. Although share prices recovered sufficiently to enable the New York stock exchange to reopen on 15 December, trading remained restricted until April 1915.

  The domestic crisis was surmounted by the use of emergency currency, and by the issue of ‘clearing house loan certificates’ to permit banks with unfavourable clearing balances to pay other banks. Externally, New York was determined to remain on the gold standard. But the exchange rate with sterling began to approach $7 to the £, when par was $4.87. With short-term bills falling due, further gold would have to be shipped abroad to hold the exchange rate. American companies placed the value of their stock held abroad at $2,400 million. The closure of the stock exchange forestalled the immediate danger of these holdings being redeemed, but it did not obviate the possibility of other debts being called in. The US Treasury reckoned that $450 million would mature in London by 1 January 1915, and a further $80 million was owed by the city of New York to London and Paris. Given that the crisis would be circumvented once American exports began to move, and given New York’s desire that the United States hold its gold, the preferred solution of the banks was for their overseas stockholders to accept credits in New York. This Britain refused to do, insisting on the shipment of gold. Britain’s stance confronted the United States with a choice. Either it declared a moratorium or it maintained payments in gold. By opting for the latter, New York sustained its financial prestige in international markets. Furthermore, it signalled to the world that other countries’ floating capital would be safe in the United States. In the event,
it achieved this at minimal cost to itself. The clearing houses established a gold fund of $100 million, to which $108 million was actually subscribed, and of which $104 million was earmarked for deposit at par in Ottawa on the Bank of England’s account. The resumption of American exports meant that the dollar was back to par by November 1914, and in December the United States achieved a net import balance of almost $4 million in gold. Only $10 million, therefore, was actually deposited in Ottawa.33