To Arms

by Hew Strachan

  The first Liberty Loan was issued at par on 24 April 1917. The banks advised that a maximum of $1,000 million dollars could be placed at an interest rate of 4 per cent. McAdoo, persuaded by his own faith in popular patriotism, opted for $2,000 million at 3.5 per cent. The bonds matured in 1947, but the Treasury could redeem them after fifteen years. The smallest unit was $50, but special bonds of $10, which could be grouped into units of $100, were made available. Employers allowed employees advances on their salaries; firms fostered liquidity by declaring extra dividends; payment could be spread over five instalments. McAdoo’s faith was rewarded with $3,035 million, subscribed by 4.5 million individuals. The bond-holding public in the United States expanded over ten times. Applications were therefore scaled down. Of the total subscribed, 42 per cent was in blocks of between $50 and $10,000; but of the $2,000 million of allocated units, 65 per cent was in this lower range. The effect was to restrain the benefits of the generous tax exemptions which the bonds offered. They were liable only for estate and inheritance duties, and thus a person paying income tax at the top rate of 67 per cent was being given the equivalent of 10.6 per cent in interest.384

  McAdoo had been authorized to take out a loan of $5,000 million. He had therefore $3,000 million in hand. In August 1917 he requested authority to float the second Liberty Loan, which would incorporate the unused $3,000 million and add a further $4,500 million. His aim was to withdraw the privileges which the first loan had accorded the wealthy and to woo those on lower incomes. The new loan was therefore liable to supertax and to excess profits duty. In return the interest rate was raised to 4 per cent. The loan attracted 9.4 million subscribers, and raised $4,617.5 million. Only $568 million of the first loan was converted: for most of its holders tax exemptions were more valuable than an increase in interest rate.

  By the time McAdoo applied to issue the third Liberty Loan, in April 1918, his policy was showing signs of strain. It had failed to win over the excess purchasing power of lower-income groups; its low rate of interest meant that the existing Liberty Loans traded below par; and only after the first loan had the government—albeit briefly—been free of debt. Local quotas were set as targets to popularize the new loan. McAdoo wanted to issue the stock at 4.25 per cent, in ten-year non-convertible bonds. The banks advised that non-convertibility should be compensated for by a rate of 4.5 per cent, not least because the government would not have to bear the higher rate on its earlier issues. The Treasury was authorized to buy up to 5 per cent of any of the issues in any one year in order to sustain the market price. To encourage investors to hold the bonds, they were made redeemable at par plus interest in payment of estate and inheritance taxes. No provision was made for purchase in instalments. The effect was, once again, to make the issue relatively more attractive to the wealthy. Of 18,376,815 subscribers who put up $4,176.5 million, 18,354,315 contributed $2,770.9 million in units ranging from $50 to $10,000. Thus, 99.8 per cent of subscribers received 66.5 per cent of the issue.

  For the fourth Liberty Loan, in October 1918, the Treasury gave in to the market. All the Liberty Loans were trading below par, but the first had remained better priced than the others because of its tax exemptions. Therefore the fourth loan was exempt from surtax, excess profits duty, and war profits duties. For those who bought the fourth loan the exemption was extended to their holdings of the second and third issues. On this basis the interest rate could be held at 4.25 per cent, and the fifteen-to-twenty-year bonds made inconvertible. Over 22 million people subscribed $6,993 million for an issue of $6,000 million: most of these (85 per cent) wanted $50 and $100 bonds, but that accounted for only 9.8 per cent of the total sum.385

  Including the Victory Loan (issued after the war had ended), only 20 per cent of the debt outstanding in June 1920 was held in units of $50 or $100, and some of these smaller denominations had been bought by companies as dividend payments for their shareholders. Thus, the bulk of American war loans were subscribed by the wealthy. Companies themselves had significant holdings: the United States Steel Corporation took almost $128 million of Liberty Loan stock.386 But the failure of McAdoo’s grandiose vision was only relative to its own ambition. Over a fifth of the population of the United States applied for the fourth loan. Moreover, McAdoo himself recognized that alternative devices were needed to reduce the purchasing power of lower-income groups, and in January 1918 imported from Britain the idea of war savings certificates. Denominations of $5 were sold at $4.12, and gained 1 cent towards their final redemption value in each succeeding month. Thrift stamps, valued at 25 cents, could be collected towards the price of one war savings certificate. Monthly sales averaged $50 million, and in July 1918 they peaked at $211.4 million. In 1918 as a whole $962.6 million was raised through war savings certificates. But the scheme was too late in adoption and maturity too short-term for it to have a major deflationary effect.387 McAdoo had been determined to restrict short-term debt, but in June 1919 it stood at 14 per cent, less than elsewhere but not significantly below that of Britain.388 If McAdoo had really wanted to draw in the subscriptions of those on lower incomes, to attract spenders not savers, he would have had to forgo tax exemptions and to raise interest rates.

  However, it was only the post-war preoccupation with inflation that cast the policy of low interest rates into doubt. During the war their effect was not entirely nugatory. Obviously the state, as the principal borrower in the market, benefited from the cheapness of money. This was a direct advantage. Indirectly, the success of the whole Liberty Loans scheme came to rest on low interest rates. The Liberty Bond act banned banks from using the bonds as security for note issues. Formally speaking, their task was to take up the certificates of indebtedness—the short-term stock, not the long-term. However, the act permitted all banks, including those which were not members of the Federal Reserve System, to accept deposits; it also released member banks from their reserve requirements in relation to deposits of government funds. The Federal Reserve banks increased their loans to commercial banks from less than $20 million in early 1917 to around $2,000 million in mid–1919. The commercial banks then offered preferential rates to clients seeking advances to buy Liberty Loans. The discounts of the members became increasingly secured by government stocks, and their own rediscounts were then secured on their holdings of these stocks. In January 1918 31.9 per cent of the banks’ rediscounts were secured by government obligations; by the end of the year the figure was 70 per cent. The banks’ holdings of government obligations rose 233 per cent, from $1,546 million in June 1917 to $5,147 million in June 1919. Thus, subscriptions to the loans rested on bank borrowings which themselves relied on low rates of interest.389

  The consequent increase to the money supply was not more damaging because the United States’s entry to the war was late, and its experience of war finance more restricted in time than that of the other belligerents. But of course low interest rates did not only serve America’s own liquidity requirements in 1917–18. They were essential to the finances of its Entente partners. By April 1917 British, French, and Italian spending in the United States, funded principally through debt contracted in America in the first place, was so great that only America’s active belligerence seemed capable of shoring up their international credit.

  FOREIGN BORROWING

  Foreign borrowing fulfilled two main and interlocking objectives. First, it provided the funds with which to buy in imports. In peace, imports were— in ideal circumstances—paid for through exports, but in the war military demands on domestic industry eliminated any surpluses for overseas trade. Secondly, it could be used to manipulate exchange rates. The pressures of the war on a belligerent—a fall in exports, an increase in inflation, the possibility of defeat—tended to depreciate its currency against those of neutral powers. But by acquiring foreign funds for its own purposes, the belligerent could staunch depreciation. Thus the costs of foreign purchases could be controlled and, in the longer term, the path to post-war reintegration in international commerce e
ased.

  However, Germany’s need to achieve these two objectives was rendered ambiguous by the blockade. With the loss of 44 per cent of its merchant fleet and the curtailment of its exports, not only through the blockade but also by dint of domestic demand, invisible earnings slumped. The tendency of its wartime rhetoric was to make a virtue of necessity. ‘Das Gelde im Lande’,390 the retention of wealth at home through the inability to import, became a clarion-call of propaganda; Helferrich lauded autarky as Germany moved towards a form of neo-mercantilism, stressing the economic reinvigoration that would be achieved through reliance on domestic resources and industrial ingenuity.391

  At first policy followed the public posturing. Foreign creditors were denied access to German courts, and neutral funds thereby rebuffed.392 But in practice Germany could not continue to be so xenophobic. Imports, albeit in smaller quantities, continued to arrive through the neutral states on its borders, and they had to be paid for. Its conquests, especially in France and Russia, forced it to acquire francs and roubles in order to administer the occupied territories. Warburgs called in short-term foreign assets to the tune of 241 million marks, particularly from the United States, via Amsterdam.393 In 1915 the Russians suspected that roubles reached the Germans from Sweden.394 In 1916 both francs and dollars were channelled through Switzerland. Thus remittances continued, not only between the Central Powers and their non-aligned neighbours, but even between the two opposing camps by way of neutral intermediaries.395 Ethel Cooper, an Australian living in Leipzig, continued to receive payments in sterling into 1917, and did so at increasingly favourable rates of exchange.396

  The exchange rate which mattered most was that between the mark and the currencies of those neutrals with whom Germany traded. By January 1916 the mark had lost a third of its pre-war value in the Hague, New York, and Stockholm. The Bundesrat therefore made efforts to eliminate speculation on the foreign exchanges and to curb the demand for foreign exchange from importers. It gave the Reichsbank the task of preparing a list of permitted imports, and it and the other main banks were formed into a consortium licensed to deal in foreign exchange. A year later all transactions in foreign exchange, not just trading agreements, were made subject to Reichsbank control. Steps were also taken to improve the inflow of exchange.397 Both allies and neutrals importing from Germany were required to pay in their own currencies. German coal exports to Holland and Switzerland brought in a steady flow of Dutch florins and Swiss francs. In December 1917 Germany refined the system by issuing invoices in German marks but demanding payment in the appropriate foreign currency at the rate prevailing on the day of payment, thus contriving to generate a profit from its own depreciating currency. Its bid in 1918 to be paid for goods that had yet to be delivered was less successful.398

  Efforts to gain control of Germany’s foreign investments charted a similar path from voluntarism to compulsion. Germany held between 20,000 million and 28,000 million marks of foreign investments at the outbreak of the war. In 1915 the Reichsbank encouraged shareholders in possession of foreign bonds to sell them to the bank in exchange for marks. In this way it acquired $470 million on the New York stock exchange in 1915 and 1916.399 But at the same time legislation in the enemy countries was confiscating German holdings; after America’s entry and by the war’s end 16,100 million marks were forfeited.400 In August 1916 the Reichsbank calculated that, of 15,000 million marks of foreign holdings, only 2,148 million were ‘seizable’, and that of that 1,334 million marks were held by neutral powers (excluding the United States) or Germany’s allies. As 700 million marks of this final figure represented investments in Austria-Hungary which were to all intents and purposes worthless, a bare 634 million marks remained that could be easily sold.401 Efforts to encourage the transfer of privately held foreign securities and foreign currency to the Reichsbank were stepped up in August 1916, and in the new year it became mandatory to lend them to the state for the duration of the war.

  In the circumstances the mark enjoyed an extraordinary stability on the international exchanges. Germany’s efforts in January 1916 were rewarded with only a 4 per-cent variation in the position of the mark in Zurich between then and November. But the United States’s entry into the war had the effect of aligning neutral markets with those of the Entente, and so isolating the Central Powers. By October 1917 the mark had fallen 50 per cent. It recovered after Soviet Russia’s acceptance of humiliating peace terms at Brest-Litovsk, and it did not go into steep decline until the second half of 1918.402 Germany believed that the international position of the mark, in so far as it reflected inflation, did so because inflation was a product, not of domestic fiscal policy but of an adverse balance of payments. On this interpretation the recovery of Germany’s ability to trade after the war would soon restore the mark to parity. The fact that this view was shared elsewhere had its effects in wartime too, since it prevented the mark from falling as far as other economic factors might have suggested was likely.403

  At one level the comparative strength of the mark was a reflection of German weakness—an inability, thanks to the blockade, to import more. Because Germany imported less, it needed less foreign currency. Thus, the impediments to commerce also rendered less debilitating the consequences of Germany’s comparative inability to place a greater proportion of its debt abroad.

  The most important neutral money market until 1917, New York, remained all but closed. One problem was that of Germany’s representation. A secret mission headed by Heinrich Albert of the Interior Ministry in August 1914 was both over-sanguine concerning Britain’s observance of the declaration of London, and too dependent on the use of German treasury bills as payment for American goods. In spring 1915 the American moratorium on the purchase of belligerents’ loan stock was breached by the Entente’s representative, J. P. Morgan. Although in theory the path to the floating of a loan in the United States was now as open to Germany as it was to Britain, in practice Berlin had to deal with Morgan’s dominance of the market. Only the comparatively unknown firm of Chandler and Co. would act for Germany: it took $10 million in treasury bills. By the end of 1915 the Reichsbank regarded the US bill market as effectively closed. The blockade, in addition to strangling German-American trade, also checked the movement of promissory bills and other commercial paper across the Atlantic. Three American institutions were prepared to handle German business: the National City Bank of New York, the Equitable Trust Company, and the Guaranty Trust Company; but in autumn 1916 the first of these capitulated to British threats to blacklist neutral banks which dealt with Germany. Germany’s best hope seemed to be Kuhn Loeb, an associate of Warburgs. However, a plan to float a loan on behalf of the cities of Berlin, Hamburg, and Frankfurt in late 1916 was forestalled by Woodrow Wilson himself. Germany raised $27 million in the United States, just over 1 per cent of the total borrowed by the Entente over the same period.404 The blockade meant that most of the proceeds were used to fund purchases from the border neutrals rather than the United States. The money that was spent in America was allocated to funding German propaganda, and so made no direct contribution to Germany’s exchange problem or to its balance of trade.405

  The problems of access to the New York money market and of the shipment of American goods made Holland, rather than the United States, the main focus of Germany’s international borrowing by the end of 1915.406 Germany centralized its purchases and so controlled prices through the establishment of the Zentral-Einkauf Gesellschaft. By November 1915 the ZEG had imported agricultural goods valued at 684.5 million marks since January, and reckoned it needed 25.3 million marks a month. A consortium of the Deutsche Bank, Diskonto-Gesellschaft, and Warburgs, formed in the summer of 1915 to fund the ZEG’s buying, was no longer equal to the task. With the mark having depreciated 32 per cent against the guilder and with Germany importing goods to the tune of 100 million marks a month (as opposed to exports of 30–40 million), the German ambassador, Richard von Kühlmann, anticipated the collapse of German credit. By August Ge
rmany’s Dutch imports had reached 100 million marks per month, and a credit of 100 million guilders negotiated by the Dresden Bank was not even sufficient to cover the ZEG’s monthly purchases. The Dutch banks were of course flush with funds, but pressure from London hampered the negotiation of credits. On 16 December 1916 the German banks which had been authorized in January to deal in foreign currency came to an agreement with a consortium of Dutch banks based on the exchange of Dutch food for German coal and steel. The Dutch banks committed themselves to monthly credits of 6 million guilders for six months, at a 5 per-cent rate of interest. But it was still not enough: ZEG’s total imports for 1916 were valued at 2,100 million gold marks, and after America’s entry the exchange rate slumped to 2.68 marks to the guilder (pre-war parity having been 1.69). The Reichsbank shipped 50 million marks in gold at the end of June, but the principal effort was to try to get the Dutch banks to lend to German cities and communes: the local governments which co-operated with the Reich in this way were to get special treatment in the allocation of food supplies. But the terms on which settlement was reached obliged the cities to repay the marks which they borrowed from Dutch (and Swiss) firms in ten years’ time in a currency of the lender’s choice at pre-war parity.407 The Dutch were becoming fearful of their dependence on Germany and were only too aware of the mark’s vulnerability. Although gold and Belgian notes were used to help cover the trade gap over the summer of 1917, both devices were exhausted by September. Using its neighbours’ reliance on German coal once again, Germany negotiated a new credit agreement in October 1917, handled for the sake of neutrality by the Diskonto-Gesellschaft; it provided 13.75 million guilders for six months. Despite further crises in German-Dutch relations in the following spring and summer, a fresh credit of 14 million guilders was negotiated on 24 August 1918. By the end of the war Germany owed Holland 1,600 million gold marks.