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.