By David Dayen, a lapsed blogger, now a freelance writer based in Los Angeles, CA. Follow him on Twitter @ddayen
This week marks the 100th anniversary of a nearly forgotten yet critical moment in global finance. As the looming outbreak of World War I became more and more imminent when Austria made an ultimatum to Serbia in the last week of July 1914, the resulting fear in global markets set off a massive financial panic. Investors, fearing unpaid debts, pulled out of stocks and bonds in a scramble for cash, which at this point in history meant gold. The London Stock Exchange reacted by closing on July 31 and staying closed for five straight months. The U.S. stock exchange, which witnessed a mass dumping of securities by European investors in exchange for gold to finance the war, would also close on the same day, for about four months. Britain declared war while on a bank holiday. Over 50 countries experienced some form of asset depletion or bank run. Here’s an incredible statistic: “For six weeks during August and early September every stock exchange in the world was closed, with the exception of New Zealand, Tokyo and the Denver Colorado Mining Exchange.”
Some of this history of the Financial Panic of 1914 shows up in Liaquat Ahamed’s Lords of Finance, but much of it has been completely obscured, despite the enormity of the event (every stock exchange in the world closed for months?). But with markets wholly unprepared for the impact of a global military conflict, the crisis would shape the financial order for decades to come.
The two major books on this subject are Saving the City: the Great Financial Crisis of 1914 by Richard Roberts, and When Washington Shut Down Wall Street: The Great Financial Crisis of 1914 and the Origins of America’s Monetary Supremacy by William Silber. As I’m relying on these two scholars for much of my knowledge, it’s entirely possible that I’m making a hash of the history here, so do chime in if you find it lacking. Both books, or at least what I’ve been able to glean from them, have the fragrance of an agenda (certainly Silber appears partial to his protagonists). So bear with me.
In general, officials provided more support as a share of the economy in 1914 than they did in 2008. But the experience appears to have been different on either side of the Atlantic. Britain and its counterparts in Europe had established central banks, and responded to the war fear with vast infusions of liquidity through the printing press (in Britain, the Treasury rather than the Bank of England printed many of the initial notes, nicknamed “Bradburys” for Sir John Bradbury, Personal Secretary to the Treasury, who signed them).
But the United States had just passed legislation authorizing the Federal Reserve in Christmas 1913, and it was still being organized when the crisis hit. Treasury Secretary William McAdoo, a former President of the Hudson & Manhattan Railroad Company, newly married to President Wilson’s daughter, and without any political experience prior to that point, had the opportunity to administer financial policy with a relatively free hand.
With investor flight causing a rapid dissolution of the country’s gold, the backing for the dollar, McAdoo stopped additional securities sales by closing the stock market, basically a form of capital controls (According to McAdoo’s memoirs, he did this at the behest of J.P. Morgan, a former associate; he may have merely agreed to a policy already decided by the banking elites). Then he used the emergency currency provisions of the Aldrich-Vreeland Act to allow banks to issue additional bank notes, increasing the money supply. He also sought to increase agricultural exports (the main farmland in Europe being otherwise indisposed) through the Bureau of War Risk Insurance, which brought some inflows of gold back into the country. The fact that the United States emerged with their financial system relatively intact facilitated a shift from London to New York as the seat of global financial power, although the fact that the war never touched American soil probably also had something to do with it.
McAdoo’s priority, echoed more recently during our most recent financial crisis, was to attack the problem with a sledgehammer. But he also sought, again with the help of his banker friends, to position the U.S. at the center of the postwar financial world. That may have informed his responses as much as the immediate desire to avoid economic collapse; certainly, refusing to abandon the gold standard was driven by a need to remain credible globally. McAdoo tried to both save the system and push ahead in line among industrialized nations; I suppose he succeeded, though it would be only fifteen years until the stock market crashed entirely.
In an interesting piece this month in The Guardian, Larry Elliott points out that the short-term positioning in 1914 overlooked the signaling of a new economic normal:
The next 30 years saw the end of the gold standard, the collapse of global trade, a marked reduction in migration flows, the rise of protectionism and the biggest depression the world has ever seen. Annual growth rates per person in the 12 biggest western European countries fell from 1.33% between 1870 and 1913 to 0.83% from 1913 to 1950 […]
Roll forward 93 years from 1914. It’s July 2007 and there have been a few tremors in the financial markets. A few hedge funds have hit problems with their investments in US sub-prime mortgages but most traders are blissfully unconcerned. The assumption is that any difficulties are localised, minor and soluble. There is nothing to suggest this will be any more serious than the peso crisis in Mexico, south-east Asia’s meltdown, Russia’s default or the bursting of the dotcom bubble.
Again, the optimism was unfounded. When the financial markets froze up in early August 2007 it created the conditions for the near-collapse of the western banking system 13 months later.
Certain conclusions can be drawn from these two incidents.
We know far less than we think we do. In retrospect, it was obvious that the financial markets were in a highly fragile state in 2007, just as historians can find umpteen reasons why the assassination in Sarajevo led to war. Warning signs were ignored, with disastrous consequences. The foreign secretary, Sir Edward Grey, was right with his famous 1914 warning: it was a long while before the lamps came back on again: more than three decades of war, slumps and rule by brutal regimes ensued before it could be said that the crisis was over.
The after-effects of the 2007-08 crash also linger. The question is what happens next.
Then as now, crisis measures were undertaken to forestall a near-term catastrophe, and the weakness of the overall model never contemplated. It would take nearly 40 years to return to a trajectory of progress. The U.S. ascent to the top of the financial ladder in 1914 didn’t fend off the suffering of the Great Depression, and the claims that America emerged relatively better off than other developed countries out of 2008 isn’t likely to matter in the next crisis, either.
Really I wanted to recall to this incredible moment when world stock markets shut down for months at a time, revealing the incredible power governments retain to respond to events. But the Panic of 1914 was a symptom of a greater disease, of a world being dragged into the modern age. We’re at a similar moment today, so we might want to remember and study the past.
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A fascinating footnote of history. I have to wonder though, what would have happened if they didn’t have access to all of these extraordinary measures? Couldn’t shut down the markets, couldn’t print up new bills overnight, etc. What if the bank run had been allowed to run its course and drained the banks/countries’ reserves? It’s a bit hard to fight a war when you can’t pay your soldiers, can’t buy them ammunition, and can’t ship them off to go die in some hellhole thousands of miles away. What a shame that would have been, eh? The Great War averted because no-one could afford to go off and kill each other? At least, not without sorting out their domestic bank crisis first, and that could take months, ugh, by which point your war lust has gone all flaccid.
I suppose its just a fantasy of mine. Lord knows there’s always a way to dig up war funding somehow. But I think it gets to the crux of just why I don’t trust MMT at all. I don’t want a government with an infinite pocketbook. By the time the printers fail and the debased currency has hit up against real-world constraints, millions of people have had their lives ruined or cut short. Is a finite money supply (and its boom-bust cycles) such a horrible price to pay in comparison to our current unending war machine?
Shorter George: “Surely a finite money supply would have been worth Nazi dominion over Europe and Japanese slaughter across the Pacific, the millions of Americans in the dire poverty of the Great Depression and loss of the greatest peacetime economic expansion for the common man and woman.”
Can’t you cry for the poor, misused gold?
But Ben, the ‘Well of Contracts” has run dry or some would like… it seems….
skippy… OUR Kingdom for a contract… sigh~
You’re absolutely right, skippy. I don’t know what I was thinking and accept your admonishment.
I see how these might follow from the US not entering WWII, but how do these follow from George’s counterfactual of not fighting World War I?
‘Shorter George: “Surely a finite money supply would have been worth Nazi dominion over Europe and Japanese slaughter across the Pacific, the millions of Americans in the dire poverty of the Great Depression and loss of the greatest peacetime economic expansion for the common man and woman.'”
If World War I had been avoided you wouldn’t have gotten any of these things so I don’t get the point.
How would World War I have been avoided? I hate to be the one to tell you, but the industrial bases which provided the resources needed to fight were built during the gold standard era, not some imaginary “infinite money period”. How would a fixed-rate monetary system have stopped the war when there already was one in place?
Germany would never have lost WW1(likely because Germany also could not have afforded to fight it) therefore the Nazis would never have come into existence. Instead, thanks to central banking, we have Nazis running the USA and they have the resources to make the German Nazis look like some kids throwing a kindergarten temper tantrum.
Japan is a different matter but how many millions of Europeans and Americans needed to die for China? Really, unopposed, the Japanese Empire would simply have replace the empires of the British, Dutch and French in Asia.
It does kinda seem like the birth rate is at odds with the gold rate. If the human population crashed like the stock market all could be solved! Praise be to your favorite god. But, alas, it does not. Even with the hubris of all our pointless wars.
FWIW: Annual Gold Production vs Annual Population Growth
Sorry … should have mentioned to scroll down to chart #7
How could Germany not have afforded to fight WWI? Do you think they built their tanks out of paper marks?
+100!
You don’t want a gov’t with an infinite money supply? I get that. But you don’t want a gov’t with a fixed money supply, or one that is out of its control. My father lived through the Great Depression, and told me several times that inflation is bad, but deflation is worse. An inflexible money supply means that we cannot adjust to economic dangers and pitfalls. Right now, people in many countries are suffering because their gov’ts or central banks are not making enough money available.
aka the entire continent of Europe
A fascinating “what if”, George. I can’t untangle all of the complexities, but I have some thoughts and questions. Prior to the war, there was tension among various countries, such as that between Germany and Great Britain. The war started with Austria-Hungary’s ultimatum to Serbia. Even without a potentially infinite money supply, Austria-Hungary certainly had the resources to fight a war against the Serbs. There were oil fields in the Austrian province of Galicia, and much of the country was agricultural, so the army could be fed.
The Russians were allied with the Slavic Serbs, and were similarly agricultural, so they were also able to feed their soldiers. So there would have been a significant war, no matter what. The question is whether the countries that were not locally self sufficient would have entered the war. Those countries that could supply most of their needs domestically would have circulated their gold or claims on gold within their borders, and would not have been limited by their money supply. After buying locally, the governments would tax the sellers, and the cycle would continue.
I know that Great Britain had to get much of their petroleum from the United States, so they might not have been able to enter the war, because they would have run out of gold. I don’t know what the foreign exchange statuses of Germany, France, and Turkey were. Whichever of these countries was more self sufficient would have been able to fight for a longer period of time than the others. Does anyone know how effective or ineffective these countries were are supplying their own needs in 1914?
That’s a good question. I hope someone can sift back thru all the accounting and give us some insight. Self sufficiency is one good firewall against the spread of war. Now there’s an argument against complex interconnected globalization of all and everything.
GH, what a great comment. That’s my one sticking point about MMT also. Without the will to forego war, our Congress will have a heyday. I despise Congress so much I’d like to abolish Congress and institutionalize MMT in their place, run by direct democratic decisions. But that won’t happen and even so I still see MMT as the most sensible form of accounting for the domestic economy – sans military/war expenditures. So war is a Big Problem. The above summary claims that, like 1914, our financiers were engaging in some kind of “new normal” positioning in July of 2007. I’m pretty sure that positioning was planned years before. Because Little George got “elected” and took us to war for spurious reasons; because the economy had been backfiring for decades; because there was a dot.com crash which was a mere prelude to the real estate crash, and etc. But the most interesting tidbit I have found (can’t remember where, sorry) was a story about Hank Paulson jetting off to France in February of 2007 to talk with Sarko and then-FinMin Legarde to warn them that the US was going to take some kind of action re the economy. To which Lagarde is reported as saying that “We’d better all get our bathing suits on.” As there would be a financial deluge. It’s as tho’ even without a gold standard, the western world agonized over money as if it were gold and could not break their mindset.
I think you’re underestimating the level of dedication involved in the decision to go to war. Being willing to kill other people to achieve one’s policy aims takes commitment to one’s policy aims. “We can’t pay for the war” only stops those who don’t already want the war; if that had included Austria-Hungary in WWI, then they would have settled for Serbia’s counteroffer in response to their ultimatum (which was 90% of what they asked for anyway).
It is always sensible for an enterprise to separate the questions of what it can do (capability), what it will do (policy), and how it will measure them (accounting and finance). War may be the only policy decision left where national politicians still reliably make these distinctions.
Well, right now you’ve got a government with an infinite pocketbook, except (a) you’re in denial about it and (b) there’s no democratic control over the pocketbook. So which’d you rather?
Thank you so much, Dave Dayen, for this post.
It’s fascinating that nobody saw 2008 coming. I did. I clearly remember thinking, and telling friends, on my birthday in early August 2007, that the S**T was going to hit the fan due to fraudulent ratings by S&P. How did I, a complete financial ignoramus, know this? Well, it so happens I owned some McGraw-Hill stock at the time, and of course M-H owns S&P. The stock price dropped precipitously, and I got a little alert from AOL. I did a quick search as to why the stock price was falling off a cliff… and got really scared. A major ratings agency making up ratings?
“S&P rated more than $2.8 trillion of residential mortgage- backed securities and about $1.2 trillion of collateralized-debt obligations from September 2004 through October 2007, according to the complaint filed in federal court in Los Angeles.
The collapse in value of securities that packaged home loans from the riskiest borrowers led to a credit seizure starting in 2007 that sent the world’s largest economy into its longest recession since 1933 as defaults soared and home values plummeted.”
http://www.bloomberg.com/news/2013-02-14/s-p-parent-mcgraw-hill-s-rating-cut-two-steps-to-baa2-by-moody-s.html
Of course there have been no consequences whatsoever– McGraw-Hill and all the rating agencies are still riding high– because the fraudsters run the world and have each others’ backs. But I knew the crash was coming, and I knew it in August 2007. And if it was clear to me, it should have been clear to anyone with eyes to see.
It felt crazy, too. Not as crazy as it does now, though.
I have been banging on about this for years now.
This is where Keynes learned his trade as a young MMT man.
To essentially reduce internal claims on gold which would free up gold for external release so as to save his precious Central bank.
Its important to undertand that the UK had a printing press back then.
It infact had 2 !!!!
They were called South Africa and Canada.
The Gold from these printing presses found there way into friendly France (modern day Japan with its US debt) and hostile Germany (China and its vast hoarde of US debt)
Back then the Gold became more and more useless over time as it could not be spent until mobilization.
Now US Debt has replaced Gold but with almost identical effects.
I would recommend the book “A Call to Arms” by Hew Strachan in particular the chapter on how the Great War was financed.
However its important to understand this overproduction known as war was to save central banks and not debtors who were subsequently vaporized.
Thus maintaining the concentration of power.
“US debt has replaced gold.” That is just about the most profound thing I’ve realized while reading. So much so that I had to go back 3 times. And I’ll just say this, it is a giant breakthrough. It is (as Martha always says) a “good thing.” We are so damn rich, we should throw a big party. Seriously.
1) Put down the peyote; you’re working yourself into a tizzy again.
2) To what debt are you referring?
3) Currenciez were pegged to gold as a method of ensuring stable value. Now you claim that “debt” serves the same purpose, so you shoould be able to tell us the standardized unit to which the pound is pegged. Is it 35 pounds per ounce of debt? Or maybe, as debts can sometimes be on paper, the pound is pegged per inch of debt. 20, 50, 100 pounds per electron, maybe?
4) In which work can I find that Keynes wished above all to “preserve his precious central bank” (you know, the one that existed centuries before his birth)? I’m having trouble finding that chapter in The General Theory or The End of Laissaiz Faire.
5)”Keynes the MMT man”. Hmm. As I might also say that Dork of Cork is a regular Jew basher over at Stormfront. Doesn’t matter whether it’s actually true, does it? A lie is just as good as the truth and for you, apparently, easier to write.
Lay the specifics on us, brother.
After European mobilization the gold was spent and thus found its way into the US of A. which became a sort of China and Saudi Arabia in one monster package.
Hello, i’m a french reader of this blog. I wanted to signal another great book about de first world war and its connections with our moderns times. Adam Tooze, in The Deluge, wrote a splendid book about this.
This may also be of interest by a contemporary “participant” Henri Lambert–
http://www.henrilambert.eu/pages/his-reform-for-a-responsible-capitalism/systemdeficiencies/
I am currently reading Liaquat Ahamed’s “Lords of Finance”. It is a great book.
One of the many takeaways for me are a quote early in the book after WW1 started was, and this is paraphrase, of one of the banking officials stated – The first two casualties of war are the truth and a nation’s finances.
Also I gleaned from the book, at the beginning of WW1, most of the major parties involved in the war thought it would be a short event. Which is something citizens of all countries should keep in mind when their nation begins military activities. Certainly, that is a lesson the US has recently learned.
Well, there’s no doubt that we’ve experienced it, but it’s not clear that our leaders have learned the lesson.
“What we learn from history, is that we do not learn from history.”
“Those who remember the past are condemned to repeat it too.”
“There are some deductions of major importance which can be made from these premises.
The first is that money is nothing but an effect- (131) tive demand. It is not wealth, it is
not production, and it has no inherent and indissoluble connection with anything
whatever except effective demand. That is the first point, and it would be difficult to
overrate the importance of a clear grasp of it. It lies at the root of the question as to the
true ownership of credit-purchasing-power. The second point is that, so far as we can
conceive, the co-operative industrial system cannot exist without a satisfactory form of
effective-demand system, and the result of an unsatisfactory money system (that is to say,
a money system which fails to function as effective demand to the general satisfaction) is
that mankind will be driven back to the distinguishing characteristic of barbarism, which
is individual production. And the third point, and the point which is perhaps of most
immediate importance at the present time, is that the control of the money system means
the control of civilised humanity. In other words, so far from money, or its equivalent,
being a minor feature of modern economics, it is the very keystone of the structure”
CH Douglas – speaking during the interwar years.
The guy you refered to in the Saving the City Utube clip got it wrong – very wrong.
The crisis in the Uk reached its peak a year earlier at the very least AND NOT IN THE SUMMER OF 1914
The Dublin lockout of 1913 rocked the British system to its core.
Dublin was the second city of the British Isles at that time – it was the center of extraction from the Irish vassal.
The workers of Dublin were unable to consume the industrial surplus.
The UK Industrial system was unable to supply effective demand as the gilded goods produced extracted from basic demand.
IT WAS IN TOTAL FAILURE MODE IN 1913.
“War is a consumer whose necessities are so imperative that they become superior to all
questions of legal and financial restriction. Inter (134) arma silent leges. That is why
legalists and financiers, although their existing systems tend inevitably to produce wars,
are so afraid of them, and why war, terrible in itself, has so often released humanity from
bonds which threaten to strangle it. As a result of this situation, the bounds which are
placed upon production for war purposes are defined by intrinsic forces and not by
artificial limitations. That is to say, in order to maintain a connection between finance and
production, finance has to follow production instead of, as in the normal case, production
having to follow finance. The extension of production to its utmost intrinsic limits,
therefore, involves an extension of finance at a rate out of all proportion to that which
obtains in the normal course of events, and this extension at once reveals the artificial
character of normal finance. It has been pointed out at some length, and probably
sufficiently, that the Gold Standard, on which British finance was supposed to be based,
broke down within a few hours of the outbreak of war. That is important; but it is only
the first step, just as the Gold Standard itself is only one aspect of a system of finance in
which currency is the basis of credit. What is more fundamentally important, is to
observe that immediately production is expanded at (135) anything like its possible rate,
the idea that the financial costs of that expansion can be recovered in prices is seen in its full absurdity.
It will be understood that by far the major portion of the muniments of war (including not
only warlike weapons and munitions, but the million articles required by the supply
services of the armies engaged) were produced by so-called private undertakings, and
paid for by the Government. Now, the normal method by which a Government obtains
the money wherewith to pay for its purchases, is by taxation, and a balanced Budget
means that the proceeds from taxation at least cover the expenditure on public services.
Under these conditions, costs and profits of production are recovered by the Governments
(through the medium of taxation) in prices; that amount of taxation which is represented
by the supply services, representing the price of the goods delivered to the Government
with all costs included.
The National Debt rose between August 1914 and December 1919 from about six
hundred and sixty millions sterling, to about seven thousand seven hundred millions
sterling. And this rise represents, on the whole, the expenditure over that period which it
was deemed impracticable to recover in current taxation. That (136) is to say, if we take
the average taxation for supply purposes over that period 1914-1918, as being about three
hundred millions per annum, the amount paid by the public as consumer for the goods
and services supplied to it for war purposes, was about thirteen hundred and fifty
millions, and the financial cost of those goods and services was about eight thousand
three hundred and fifty millions, a ratio of cost to price of about roughly 1 : 6.2 . In other
words, goods were sold to the public at one-sixth of their apparent financial cost, and no
one lost any money over it at the time. How was this done?”
“the bounds which are placed upon production…are defined by intrinsic forces and not by
artificial limitations.”
Isn’t that just MMT in a nutshell?
Douglas was very much aganist the full employment war economy.
He described the war economy as a release from the burdens of debt but at a huge cost.
Essentially he used it as a real world example of the absurdity of finance.
Ben Johansson goes Godwin, and a straw one at that. It must be two-for-one day on the Internet.
In Ben Johannson’s mind, Hitler is always under the bed, waiting to eat him. Only loose money can keep poor Ben safe–not courage or loyalty or self-sacrifice. But for Ben, all victory was owed to MMT…
Now I say you might well resort to soft money in the midst of a major war. But does that mean that soft money should be your standard policy?
We see it again and again. Loose money means malvestment almost everywhere it is employed. Loose money makes it easier for regimes to wage wars, and makes it easier for rulers to reward their cronies. Loose money makes it easier to pursue grandiose plans for dramatic change without answering to those affected by those changes. Loose money makes it easier for powerful people and governments to externalize the consequences of all their mistakes.
With hard money, all distributions and redistributions of wealth become more visible. Theft is more visible. Exploitation is plainer to see. Political consequences of misgovernment tend to arrive sooner.
Socialism doesn’t need soft money. We can have socialism and hard money at the same time. Of course, with socialism, monetary policy no longer inhabits the summit of economic decision-making. We could have socialism with soft money, too, but I think political accountability is always better under a hard money system.
And it would make plenty of sense to many of us in the working class. In my own experiences, I find that most working class people prefer the idea of hard money.
“Redistribution and hard money!” That slogan gets right to the heart of how we must deal with the 1%.
I’m showing a yellow card on Godwin’s Law, since the Law “does not claim to articulate a fallacy; it is instead framed as a memetic tool to reduce the incidence of inappropriate hyperbolic comparisons. ” I don’t see Ben’s comparison as hyperbolic; it’s an example of the sort of extremely large, indeed world-historical, sort of task that a state is sometimes called upon to perform (and to finance).
“Socialism doesn’t need soft money. We can have socialism and hard money at the same time. Of course, with socialism, monetary policy no longer inhabits the summit of economic decision-making. We could have socialism with soft money, too, but I think political accountability is always better under a hard money system.”
+1 billion DM à la SPD
How I do loathe war.
Thank you for the historic summary of those events. I’ll try to keep my comment short.
Mankind can only channel our competetive nature, we cannot escape evolution but it appears to be accelerating based on our tools which reflect such.
At this point, the solution to one party needing to operate death controls is to
globally wage war against death itself. First by biomechanical medicine to extend life
and then seeding of our DNA into 4D considering science knows this place exists. The process is
quantum tunneling using reverse polarity, a portion of your DNA code being positive
or negatively charged electrons.
I am not aware of any possibility that ones ego or immediate personality can survive
this process. But knowing the destination and process would eliminate the fear factor
by transition at will.
Without channeling our competitive nature for such a cause there will
be war, even in a world where resources in real terms are less scarce or can be
supplied with minimul focus.
Operation Eternity has a nice ring to it, the focus and inventions is
something I would complain less about in regards to taxes for universal
healthcare. At the end of the day we gather nuts for old age and this is the
root of why wars begin when all arguments are all boiled down. Butit is of
little comfort when one is defacating in ones underwear and mobility is severely
impaired while some or many of those you loved have perished and
your lonely. The saying by a wise man still applies and may contain more meaning than
I once realized:
“What good is it to gain the whole world and lose ourselves?”