by Hew Strachan
Gradually the banks and other institutions began to disregard the moratorium. But, particularly in 1914–15, it was the Banque de France that enabled any semblance of economic activity to continue. The bank’s commercial portfolio doubled between 27 July and 1 August 1914, from 1,583 million francs to 3,041 million. By 1 October it was carrying 4,476 million francs in deferred bills. This total declined as banks elsewhere defied the moratorium. On 31 December 1915 the figure was 1,838 million francs, and by December 1918 1,028 million.106 In the rented property market, although the government provided an indemnity for up to 50 per cent of a loss scaled according to the population size of the town, it was again the Banque de France that carried most of the obligations.107 And it was the bank that provided the kick-start to activity in the share market. The Paris bourse reopened for cash business on 3 August, but then migrated to Bordeaux on 2 September, and did not return until 7 December. It remained closed for business that had been settled in late July 1914, but in September 1915 the Banque de France made 250 million francs available to the Chambre Syndicale des Agents de Change to settle floating commitments. Debtors were required to pay a tenth of their outstanding debt and interest on the remainder: the principal was then paid off in tenths, so that the debt was fully redeemed in July 1916.108
In none of this activity did the bank enjoy any form of government guarantee. Thus, while the Bank of England moved from a position of commercial independence to one where it was underwritten by the Treasury, the Banque de France was effectively self-reliant. Alexandre Ribot, who became finance minister on 26 August 1914, made a virtue of the relationship. By keeping the bank’s credit separate from that of the government, the bank would act as a restraint on the state’s increasing its issue. On 21 September Ribot committed the state to pay 3 per cent interest on the bank’s advances after the end of hostilities, rather than the nominal 1 per cent set at the start of the war. This, he believed, would be a symbol of the state’s financial self-discipline: the bank could put the extra 2 per cent into a sinking fund to wipe out the debt.109
In reality, however, any discipline in the relationship between government and bank would be undermined if there was no necessary internal self-control in the fiscal affairs of either party. On 5 August, when the 1911 agreement came into force and the bank duly advanced the government 2,900 million francs, the authorized note issue was increased to 12,000 million. The bank, with no requirement to maintain a set gold reserve, and now also released from convertibility, effectively had a free hand. Its note issue could be enlarged by decree of the council of state without reference to the assembly. At the same time the latter gave to the council of state the right to open extraordinary credits for the duration of hostilities. Ribot’s financial purism on 21 September was set against a request for a further advance from the bank of 3,100 million francs, making 6,000 million in all. When the assembly next reconvened, on 22 December, it found that the government had voted itself 6,441 million francs in extraordinary credits. Thus, the primary pressure to increase the bank’s note issue was not to ensure liquidity for the sake of business (this, after all, was effectively curtailed by the moratorium), but to meet the fiscal needs of the government. The enlargement of note circulation was the main method of state borrowing, and would in turn lead to currency inflation, the depreciation of the franc, and rising prices.110
France, of course, was not alone in using currency inflation as a means to cover its mobilization costs. Without a rapid increase in available cash the liquidity necessary for paying suppliers, financing industry, or staving off public panic would have been forfeit. Without it, too, the switch from the requirements of a peacetime economy to those of war would have been much more protracted. The success of these methods is perhaps best rendered in negative terms: none of the major powers, not even Austria-Hungary, was constrained militarily in those first few weeks of 1914 because of financial problems. But the powers were prepared to act as they did, to suspend convertibility and to borrow from their central banks, in response to what they saw as an immediate crisis, not as a long-term situation. The crucial question, therefore, would be how they managed war finance and its inflationary effects over the long term. This would require them to pace themselves, but in a race of whose ultimate length they had no better knowledge than (mostly) over-optimistic guesses.
THE LOSS OF BUDGETARY CONTROL
In January 1917 an Australian division had one officer and fifty men continuously employed in salvage operations.111 There is no reason to think that they were atypical. But their attentions were concentrated on the items that could be reused, not on those which could not. When visitors toured the battlefields of France and Flanders after the war they saw piles of rubbish—the refuse of industrialized war. Rusting rifles, rent helmets, and spent shell-cases were the obvious signs of fighting. But also there were old tin cans, discarded corrugated iron, and broken bottles, the remnants of the daily needs of millions of men over four years. The First World War was fought with equipment that was both more sophisticated and yet more vulnerable than its predecessors, that proliferated spare parts and spawned its own obsolescence. The destructiveness of its weapons was in part responsible for its wastefulness. But in addition, standards and expectations—of medical care, of rationing, and of creature comforts—were all higher. The litter sprang above all from abundance; lavishness proceeded from lack of financial limitation.
War reversed the relationships between exchequers and their spending departments. The treasuries of Europe saw their task no longer as one of restraint but as one of enablement. Karl Helfferich, an economist, a former director of the Deutsche Bank, and Reich secretary of state for finance from February 1915 to May 1916, declared after the war that he had little enthusiasm for thrift. His task, as he saw it, was not to deny departments what they wanted but to work with them. He boasted that he had acceded to every request that the army had made. The watchword in Germany—for all Helfferich’s empty efforts to rebut it—was ‘money plays no role’112. And attitudes were little different among the Entente powers. Lloyd George, as Britain’s chancellor of the exchequer on the war’s outbreak and prime minister at its conclusion, set the tone. Although chancellor since 1908, he never, in Keynes’s view, ‘had the faintest idea of the meaning of money’.113 After resolving the crisis of July 1914, Lloyd George neglected his departmental business for the wider world of the war as a whole. Octave Homberg, meeting him in December, reported to Ribot that he ‘seems to know nothing of financial affairs and is above all a politician’. By May 1915 discontent within the Treasury made his continuation there insupportable114. His transfer to the government’s prime spending department, the Ministry of Munitions, completed the erasure of any instincts for economy he had once possessed. For the rest of the war the only limits on Lloyd George’s mobilization of resources for the purposes of victory were those imposed by physical availability, not those suggested by cost.
That governmental restraints on spending were easing was evident—albeit to different degrees—before 1914. The demands of the pre-war arms race had already pushed back the frontiers of financial control. In Britain the quest for ‘national efficiency’, not least in relation to defence, had forced the Treasury to defer to specialist advice, regardless of financial orthodoxy115. Between 1900 and 1913 Britain had the highest defence spending per capita in the world.116 But Britain could afford it: it also had the highest per capita income. And so it was able to observe two cardinal principles before 1914: expenditure should be paid for out of revenue, and parliament had the ultimate authority to approve the budget. In the other belligerent countries the combination of weak parliamentary systems, ill-developed systems of taxation, and of rising defence budgets at a time of increasing expenditure on social benefits fostered devices and deceits in peace which would flourish and grow in war. Accounting ploys and deficit financing were lessons already well learnt by 1914. Helfferich and Lloyd George might therefore protest that they did no more than preside over trend
s already in place.
Helfferich’s predecessor but one, Adolf Wermuth, finance minister from 1909 to 1912, had argued as a British chancellor of the exchequer would have done. Without a thriving economy and a secure financial base, an enhanced defence capacity would have nothing to protect. Wermuth resigned rather than preside over the 1912 and 1913 army laws. The 1912 budget approved defence expenditure up until 1917 without making clear how it was to be funded; the army, like the navy, was manoeuvring into a position where its growth would be autonomous, independent of Reichstag control. The 1913 budget appropriated 61.8 per cent of its total for military purposes: military spending rose 62.9 per cent from 1910, when it had been 49.1 per cent of the total budget. Thus the Reich’s financial arrangements were already being ‘militarized’ before the war broke out. The Bavarian finance minister said of the tax which resulted, ‘in truth it is . . . a war contribution in advance . . . not a tax, but a sacrifice, a patriotic gift’117.
The new tax, a direct levy on property to run for three years, meant that Germany’s 1914 budget—although drawn up in peace—contained an element which suggested that it was appropriate for war. Hermann Kühn, Wermuth’s successor, did not see the need to revise the budget when war broke out, and Helfferich followed its outline in 1915 and to some extent in 1916. However, the new principles of the defence tax were overshadowed by a legacy of financial laxity, manifested in two interlocking elements in the budget.
The first of these was the burden of debt. On 31 March 1914 the Reich’s total debt was 5,441,897,600 marks, all but 524 million of which was long-term and interest-paying118. The second significant continuity was the extraordinary budget. Technically this was for capital improvements and was therefore self-amortizing: it was funded by loans, the interest and redemption of which were met by the ordinary budget. But the strain of rising defence costs before the war had eroded the rigour implicit in these arrangements. Loans were being used to meet recurrent expenditure, including not only defence costs but also interest and redemption payments. Furthermore, the expenditure for the redemption of debt appeared as a charge on the ordinary account, but as an income on the extraordinary. Provided ordinary receipts, including new loans, met ordinary outgoings, and provided transfers to the extraordinary account covered that element of the budget’s outgoings, the Reich avoided declaring a deficit. Formal deficits or surpluses could appear because it was possible to carry forward extraordinary allocations from the previous year as income for the new year. This rolling over of accounts obscured whether the deficit was real or not—and in any case, even if it were, it could be simply resolved by the contraction of fresh debt.119
It was intended in the 1914 budget to break this cycle by balancing the ordinary budget through the defence tax. But with the outbreak of war all the additional military costs created by hostilities were pushed into the extraordinary account, which was funded through credits. In 1915 and subsequently even peacetime defence expenditure was shifted out of the ordinary account, and thus that aspect of the budget was reduced in line with the reduction in the receipts for ordinary income120.
The effect was to remove from Reichstag supervision the auditing of the war’s financing. The Reichstag’s concerns were effectively narrowed to those costs which could not be transferred to the extraordinary budget. Not once throughout the war did it review Germany’s financial policy as a whole.121
Arguably this would have happened anyway. On 4 August the Reichstag itself voluntarily gave up what oversight it had by empowering the Bundesrat to adopt the financial measures it deemed appropriate. Thereafter, so compelling and immediate were the needs of the war that no nation, including Germany, could manage its funds according to an annual budget: what mattered was the monthly cash flow. In addition, as elsewhere, proper controls were the casualty of conscription: insufficient men remained to keep tallies and to collect taxes.
Germany’s domestic political agenda—the services’ battle to be independent of parliamentary control, the Bundesrat’s clash with the more liberal and more democratic Reichstag—created the context into which the issues of war finance irrupted. Thus, its experiences were more characteristic of its forms of government than of its military situation. In this it had at least something in common with its main ally Austria-Hungary. Admittedly, the latter’s difficulties in central control and accountability, with its finances divided between the two monarchies in war as in peace, were entirely sui generis. But, like Germany, the best of the finance ministries’ staffs, at the top as well as the bottom, were called to other duties. When Alexander Spitzmüller, who had left the Austrian government’s employ to become president of the Creditanstalt bank in 1909, was appointed to head the Austrian finance ministry in December 1916 he found that it had been split into too many departments, that it lacked strong leadership to give it unity, and that it was ‘no longer the elite instrument of national and political economy’.122
In many ways, however, the more obvious comparison between Germany and its allies was with Bulgaria, which joined the Central Powers in July 1915. Bulgaria, like Germany, used the device of an extraordinary budget to fund its war effort. As a result, its ordinary account showed a surplus in 1917 and 1918. Only in the latter year did the outgoings on the ordinary account increase, by about 41 per cent, and in real terms inflation meant that the expenditure charged to the account was constant. Indeed, the depreciation of the Bulgarian currency, the lev, ensured that by 1918 actual spending on the ordinary account had fallen to 27 per cent of its 1914 value. Even in 1911, the last full year of peace for Bulgaria, 21.7 per cent of the budget was devoted to direct defence spending, and debt charges, many of which arose from the acquisition of military equipment abroad, was responsible for a further 20 per cent. After 1915 all military expenditure, including the peacetime costs of the army, was shifted into the extraordinary account. Beginning in 1916, any attempt at an annual statement was abandoned in favour of monthly credits in twelfths. The extraordinary account duly multiplied by a factor of 14.4 between 1914 and 1918. Again, depreciation limited the real cost, which peaked at a threefold increase on the 1914 figure in 1917, and by 1918 the combined values of both ordinary and extraordinary accounts had declined 45 per cent on their 1914 totals. But the accounts understate the price of Bulgaria’s war. About half of wartime expenditure was simply unbudgeted. Using the protocols of the civil and military authorities, the state borrowed from the national bank of Bulgaria, Bulgarska Narodna Banka, without cover or with, at best, the security of provisional receipts or anticipated post-war extraordinary credits. At any one time the Treasury had no idea of its current commitments, let alone its anticipated outgoings.123
Of the Entente powers, Russia was most akin to Bulgaria in its practices. Between 1900 and 1913 Russia’s state spending rose 93 per cent, but its national income increased only 80 per cent. The finance minister and future chairman of the council of ministers, V. N. Kokovtsov, alarmed by military spending which accounted for 43 per cent of the budget in 1909–10, tried to bring the armed services under control. He did reduce the national debt, from 9,054 million roubles in 1908 to 8,825 million in 1913, so that its cost was 13.7 per cent of the budget as against 16 per cent. Nonetheless, military spending rose over the same period. The navy’s expenditure grew 178.4 per cent and the army’s 43.1 per cent. Russia’s ostensible financial health was confined to its ordinary budget, whose revenue was derived from the state railways, state monopolies, and taxation, and a quarter of whose expenditure was allocated to the services. Its extraordinary budget, funded through loans, was what shouldered spending on railways and on the major arms programme of 1914.124
As in Germany, the principle of the extraordinary budget was extended on the outbreak of hostilities. Russia’s fundamental laws gave the Tsar the power to authorize additional wartime spending for all government departments, and also to raise state loans to fund it. The war could effectively be financed out of the war fund, and be totally independent of the Duma. The ordina
ry budget continued as it had before the war—and remained subject to the Duma and to the state council. The absurdity of this position was clear from even the most superficial glance at the accounts as presented to the Duma. Those for 1914 showed a deficit of 242.7 million roubles on the ordinary and extraordinary budgets; those for 1915 moved into surplus, and for 1914–17 as a whole recorded a favourable balance of 2,190.7 million roubles. Ordinary spending in 1915 was actually recorded as 452 million roubles below that of 1913.
Two things were happening to obscure the true state of Russia’s finances. First, into the war’s expenditure were transferred not only the additional military costs generated by the fighting but also the normal expenses of the services’ peacetime establishment. Secondly, many items of non-military expenditure, particularly spending on state railways, but also other capital projects, were billed to the war. By 1916 10 per cent of all civil outgoings were channelled through the war fund. Between the outbreak of war and August 1917 41,392.7 million roubles had been appropriated for the war fund, 20 per cent of it for government departments other than the army and the navy. Thus, even the apparent health of the ordinary budget was in reality misleading: ordinary revenue was not covering ordinary expenditure. The gravity of the position was further underlined by the fact that much of the revenue in the ordinary budget was generated by the profits of war industry or by customs duties on the services’ imports. If the war had ended in 1916 the ordinary budget was likely to have been up to 2,000 million roubles in deficit.