Carroll Quigley - Tragedy and Hope - A History of the World in Our Time

The attitudes of bankers were revealed most clearly in England, where every move was dictated by efforts to protect their own position and to profit from it rather than by considerations of economic mobilization for war or the welfare of the British people. The outbreak of war on August 4, 1914, found the British banking system insolvent in the sense that its funds, created by the banking system for profit and rented out to the economic system to permit it to operate, could not be covered by the existing volume of gold reserves or by collateral which could be liquidated rapidly. Accordingly, the bankers secretly devised a scheme by which their obligations could be met by fiat money (so-called Treasury Notes), but, as soon as that crisis was over, they then insisted that the government must pay for the war without recourse to fiat money (which was always damned by bankers as immoral), but by taxation and by borrowing at high interest rates from bankers. The decision to use Treasury Notes to fulfill the bankers’ liabilities was made as early as Saturday, July 25, 1914, by Sir John Bradbury (later Lord Bradbury) and Sir Frederick Atterbury at the latter’s home. The first Treasury Notes were run off the presses at Waterlow and Sons the following Tuesday, July 28th, at a time when most politicians believed that Britain would stay out of the war. The usual Bank Holiday at the beginning of August was extended to three days during which it was announced that the Treasury Notes, instead of gold, would be used for bank payments. The discount rate was raised at the Bank of England from 3 percent to 10 percent to prevent inflation, a figure taken merely because the traditional rule of the bank stated that a 10 percent bank rate would draw gold out of the ground itself, and gold payments need be suspended only when a 10 percent rate failed.

At the outbreak of the war, most of the belligerent countries suspended gold payments and, to varying degrees, accepted their bankers’ advice that the proper way to pay for the war was by a combination of bank loans with taxation of consumption. The period within which, according to the experts, the war must cease because of limited financial resources eventually passed, and the fighting continued more vigorously than ever. The governments paid for it in various ways: by taxation, by fiat money, by borrowing from banks (which created credit for the purpose), and by borrowing from the people by selling war bonds to them. Each of these methods of raising money had a different effect upon the two chief financial consequences of the war. These were inflation and public debt. The effects of the four ways of raising money upon these two can be seen from the following table:

a. Taxation gives no inflation and no debt.

b. Fiat money gives inflation and no debt.

c. Bank credit gives inflation and debt.

d. Sales of bonds give no inflation but give debt.

It would appear from this table that the best way to pay for the war would be by taxation, and the worst way would be by bank credit. However, taxation sufficient to pay for a major war would have such a severe deflationary effect upon prices that economic production would not increase enough or fast enough. Any rapid increase in production is spurred by a small amount of inflation which provides the impetus of unusual profits to the economic system. Increase in public debt, on the other hand, contributed little of value to the effort toward economic mobilization.

From this point of view, it is not easy to say what method of financing a war is best. Probably the best is a combination of the four methods mixed in such a way that at the end there is a minimum of debt and no more inflation than was necessary to obtain complete and rapid economic mobilization. This would probably involve a combination of fiat money and taxation with considerable sales of bonds to individuals, the combination varying at different stages in the mobilization effort.

In the period 1914-1918, the various belligerents used a mixture of these four methods, but it was a mixture dictated by expediency and false theories, so that at the end of the war all countries found themselves with both public debts and inflation in amounts in no wise justified by the degree of economic mobilization which had been achieved. The situation was made worse by the fact that in all countries prices continued to rise, and in most countries public debts continued to rise long after the Armistice of 1918.

The causes of the wartime inflation are to be found in both financial and economic spheres. In the financial sphere, government spending was adding tremendous amounts of money to the financial community, largely to produce goods which would never be offered for sale. In the economic sphere, the situation was different in those countries which were more completely mobilized than in those which were only partly mobilized. In the former, real wealth was reduced by the diversion of economic resources from making such wealth to making goods for destruction. In the others, the total quantity of real wealth may not have been seriously reduced (since much of the resources utilized in making goods for destruction came from resources previously unused, like idle mines, idle factories, idle men, and so on) but the increase in the money supply competing for the limited amounts of real wealth gave drastic rises in prices.

While prices in most countries rose 200 to 300 percent and public debts rose 1,000 percent, the financial leaders tried to keep up the pretense that the money of each country was as valuable as it had ever been and that as soon as the war was ended the situation existing in 1914 would be restored. For this reason they did not openly abandon the gold standard. Instead, they suspended certain attributes of the gold standard and emphasized the other attributes which they tried to maintain. In most countries, payments in gold and export of gold were suspended, but every effort was made to keep gold reserves up to a respectable percentage of notes, and exchanges were controlled to keep them as near parity as possible. These attributes were achieved in some cases by deceptive methods. In Britain, for example, the gold reserve against notes fell from 52 percent to 18 percent in the month July-August 1914; then the situation was concealed, partly by moving assets of local banks into the Bank of England and using them as reserves for both, partly by issuing a new kind of notes (called Currency Notes) which had no real reserve and little gold backing. In the United States the percentage of reserves required by law in commercial banks was reduced in 1914, and the reserve requirements both for notes and deposits were cut in June 1917; a new system of “depositary banks” was set up which required no reserves against government deposits created in them in return for government bonds. Such efforts were made in all countries, but everywhere the ratio of gold reserves to notes fell drastically during the war: in France from 60 percent to 11 percent; in Germany from 59 percent to 10 percent; in Russia from 98 percent to 2 percent; in Italy from 60 percent to 13 percent; in Britain from 52 percent to 32 percent.

The inflation and increase in public debts continued after the war ended. The causes for this were complicated, and varied from country to country. In general, (1) price fixing and rationing regulations were ended too soon, before the output of peacetime goods had risen to a level high enough to absorb the accumulated purchasing power in the hands of consumers from their efforts in war production; thus, the slowness of reconversion from war production to peace production caused a short supply at a time of high demand; (2) the Allied exchanges, which had been controlled during the war, were unpegged in March 1919 and at once fell to levels revealing the great price disequilibrium between countries; (3) purchasing power held back during the war suddenly came into the market; (4) there was an expansion of bank credit because of postwar optimism; (5) budgets remained out of balance because of reconstruction requirements (as in France or Belgium), reparations (as in Germany), demobilization expenses (as in the United States, Italy, and so on); and (6) production of peacetime goods was disrupted by revolutions (as in Hungary, Russia, and so on) or strikes (as in the United States, Italy, France, and so on).