To Arms

by Hew Strachan

  On 19 July he was warned that an ultimatum would be delivered to Serbia, but was told that this would happen on 25 July. On 20 July he learnt that the deadline for the ultimatum was now 23 July, and that he should anticipate the mobilization of eight corps. As a result of his experience in the earlier crises he knew that this could not be achieved by normal credit operations. Nonetheless, the easier conditions in the money market encouraged the banks to accept that the message should be one of calm and continuity. Foreign withdrawals of gold had begun after Franz Ferdinand’s assassination. The bank raised the interest rate to 5 per cent on 26 July, but still the withdrawals continued. Its holdings of gold and foreign exchange fell by 148 million crowns in the last week of July. Nonetheless, Popovics had room for manoeuvre. He had actually reduced liquidity in the first three weeks of the month—total circulation had fallen by about 200 million crowns80—and therefore a decision to print 400 million crowns on 23 July to meet the army’s cash needs still left a cover—despite the outflow of gold—of 58 per cent on 26 July.81

  Then, on 30 July, the ground shifted again. General mobilization was ordered for 31 July. So far provision had been made to cover the costs of partial mobilization for fifteen days from existing sources. The finance ministers of the two monarchies had begun discussions with a view to borrowing 600 million crowns from an Austrian banking consortium and 340 million from a Hungarian consortium in the event of partial mobilization running beyond fifteen days. The governments planned to borrow at a rate of 5 per cent and repay their debt on 1 February 1917. Now 2,000 million crowns, 1,272 million from Austria and 728 million from Hungary, were required; the state would pay interest at 1 per cent and the Austro-Hungarian Bank, through whom the loan would be channelled, was relieved of the burden of tax payments on note circulation.

  On 31 July the interest rate was raised to 6 per cent, and on 2 August, following the Bank of England’s rise to 10 per cent, to 8 per cent. But Austria-Hungary’s only real protection from the run on gold was to come off the gold standard. On 5 August the policy settled between the finance ministers and the bank reserved gold for military and state use; foreign payments were banned. On the previous day the Bank act was suspended, relieving the Austro-Hungarian Bank of the need for its 40 per cent gold cover. The security on the bank’s note circulation now became the loans which the bank provided the government to enable it to wage the war. By the year’s end the money in circulation had increased 91 per cent on its 31 July figure.82 When current account deposits are included and the comparison shifted back to 23 July, the total circulation had grown from under 2,500 million crowns to over 6,500 million.83

  The confusion of Austria-Hungary’s financial mobilization was compounded by its use of the moratorium, first imposed on private transactions for a two-week period on 31 July. It created panic and contributed to the shortage of small change. But it was then extended to 30 September, to allow people to accustom themselves to the new economic conditions. By the time of the third extension, on 27 September to 30 November, creditors were becoming restive. The moratorium was therefore partial, providing for the settlement of 25 per cent of a debt after 15 October. At the same time the legal machinery was set up to protect small businesses which had valid reasons for not satisfying their creditors; the effect was to allow enterprises that would not have been viable in peace to limp on in war. Up to 31 August 1917 2,552 concerns became subject to this legislation, but of 1,885 cases actually referred to the courts only 110 resulted in bankruptcy. The moratorium itself was extended three more times, on 25 November 1914, 25 January 1915, and 22 December 1915, each extension permitting settlement of further tranches of debt (normally 25 per cent of a demand at a time). The moratorium was not fully lifted until 31 December 1916. Inflation over this period meant that many debts were effectively wiped out by the time they fell due.84

  The impact of the moratorium on private credit had national repercussions. Savings banks, deposits having been withdrawn in the period up to 31 July 1914, could not win them back again until 1915. The government, having moved to credit operations at the outset, found that the banks could not unlock their deposits, and—after securing its first advance—had to turn directly to the Austro-Hungarian Bank for funds. By the same token, loans could not be floated for public subscription.

  Partly in order to meet this last need, but principally to finance business, Austria-Hungary aped its German ally and set up Kriegsdarlehenskassen on 20 September 1914. The aim was to meet the demand for cash and at the same time to furnish credit against exports whose markets had been cut off by the war. However, the shortage of goods in relation to purchasing power meant that commodities tended to find a domestic market: sugar was the only major product to be mortgaged in quantity. More significant in the books of the Kriegsdarlehenskassen were shares (by the end of 1915 they had accounted in Austria for advances of 140.77 million crowns, as against 18.7 million in goods and 0.96 million in book credits). With the empire’s stock exchanges having closed after 24 July,85 assets had become frozen at an early stage in the crisis. Initially the Kriegsdarlehenskassen would only take over the rather conservative range of stocks admitted as security by the banks before the war, but the list of negotiable shares was gradually extended. The Kriegsdarlehenskassen issued in exchange non-interest-bearing treasury notes, which were effectively treated as money and were exchangeable for cash at the Austro-Hungarian Bank. However, the Kriegsdarlehenskassen did not have the inflationary effects of their German prototypes. The maximum issue was set at 500 million crowns for Austria and 290 million for Hungary. By the end of 1915 231.27 million crowns had been disbursed in Austria, but only 105.36 million was still in circulation. In Hungary the peak demand of 22 million crowns had already fallen to 16 million by the end of 1915. As liquidity returned and the moratorium eased, and as savings banks’ deposits recovered, so the Kriegsdarlehenskassen became redundant and their loans repaid. In 1916 only 62 million crowns were issued in Austria. The quantity of notes in circulation never even approached the legal maximum until the final collapse of the empire in October 1918.86

  In Germany and Austria-Hungary the establishment of the Darlehenskassen relieved the central banks of the day-to-day deposit business, thus enabling them to concentrate on a much closer relationship with the state. In neither Russia nor France was this the case. In the two Entente powers the central banks simultaneously funded their states’ mobilization needs and supported the continuation of commerce.

  Nonetheless, when considering Austria-Hungary’s mobilization, Popovics—even in 1925—could look ruefully across to the comparatively greater financial preparedness of his country’s major foe in 1914, Russia87. In the runup to the outbreak of the war Austria was struggling to recoup its gold reserves, while Russia’s monetary base looked impressively strong. On 29 July 1914 2,357 million roubles were in issue: 1,633.4 million of them were in notes, and 48.2 per cent of those were in small denominations. Only 463.7 million roubles in gold were circulating, and 260 million in other metal. Most of Russia’s gold was in the bank: 1,603.8 million roubles were held in the State Bank at home and 140.7 million abroad or in foreign drafts.88 The note cover was thus approximately 100 per cent.

  Like Germany in 1870–1 and Austria-Hungary in 1908–9, Russia had an experience of financial mobilization on which to draw. On 14 January 1906, as a consequence of the Russo-Japanese War and the 1905 revolution, Russia’s gold reserve was reduced to 700 million roubles against a note issue of 1,207.5 million. But Russia was not forced off the gold standard. Foreign loan stock boosted the gold reserves back up to 1,190.6 million roubles within a year, as against a note issue of 1,194.5 million. Russia paid over the odds for its foreign money (as it kept interest rates high), and it needed a lot of it; therefore, despite its grain exports, it had a balance of payments deficit. In addition, the costs of military re-equipment and re-expansion after 1905 pushed the budget into deficit, even if the size of the deficit was obscured.

  Russia was financ
ially more ready for war in 1914 than this recent history might suggest. The pace of its economic growth was reducing its burden of debt in real terms. In 1913 increased state revenues and a good harvest meant that the surplus on the ordinary account wiped out the debt on the extraordinary account. Moreover, its response to the confrontations and mobilizations in the Balkans was not the hawkishness of Bilinski but renewed caution. On 27 March 1914 Peter Bark, the finance minister, declared that ‘at the present time we are far less prepared for war than ten years ago’.89 He was wrong, but it was this conservative approach to monetary matters which determined Russia’s pecuniary preparedness in 1914.

  Russia’s international credit was of short duration and its fiduciary reputation slender. Witte had established a gold standard in 1897 far more rigorous than that applied elsewhere: foreign confidence was essential if Russia was to attract foreign investment. Thus, the State Bank was required to maintain a minimum gold cover of half its note circulation; if the latter exceeded 600 million roubles, then the cover for the excess was to be of equal value. The greatest demand for notes fell in the autumn, when the crops were harvested but before overseas remittances were received. Therefore the gradual increase in the State Bank’s gold reserves in the first half of 1914 reflected its desired annual cycle90.

  The determination with which Russia cleaved to the gold standard displayed a greater awareness than was necessarily shown elsewhere of its two distinct functions—its external as opposed to its internal role. On 5 August Russia suspended specie payments, thus making its notes unconvertible. But the State Bank’s own holdings of gold only dipped slightly, to 1,558 million roubles in January 1915, and by 14 January 1916 had reached a high of 1,613 million. During 1916 gold reserves fell, to 90 million roubles in May, but domestic production brought them back up to 1,474 million in January 1917. What forced Russia finally to abandon the international gold standard in March 1917 was the domestic depreciation of the rouble, not an inability to export gold abroad.

  On 5 August 1914 the State Bank was authorized to issue 1,200 million roubles above the legal maximum. The Treasury, with cash balances of only 580 million roubles in hand, was, therefore, turning to the State Bank to fund mobilization. In return, the bank discounted short-term treasury bills, but never to the same value as the notes required by the Treasury. Thus, on 1 January 1915 the State Bank held 656 million roubles in treasury bills, but the note circulation had increased by 1,171 million roubles.91

  In addition to its role as a central bank tied to a close relationship with the government, the State Bank was also the linchpin in commercial credit. Therefore, the peacetime official rate of interest was—unusually for a central bank— below the market rate: in 1912 the State Bank’s rate was already 5 per cent, and the market rate was 6 or 6.5 per cent. With rates set deliberately high to attract foreign funds, an increase in the official rate to 6 per cent on 29 July was not unsettling. The message of the State Bank was calm and continuity. The moratorium was limited and brief. Its only major sign was the closure of the stock exchange on 29 July. As the government feared a flood of redeemed Russian securities from abroad it remained closed, except for a limited period in February 1917.

  However, in the five years before 1914 Russian commercial banking had expanded significantly. In 1908 2,969 million roubles were held in deposits and current accounts; by 1913 the total was 5,228 million. In 1909 the share capital of the thirty-one commercial banks was 236.6 million roubles. In 1910 eleven of these banks increased their capital by 70 million roubles, and in 1911 thirteen banks increased theirs by 80 million and in 1912 by 100 million. In 1912 there were 776 credit houses, of which 172 had been founded in 1911: their capital totalled 120 million roubles as against deposits of 500 million roubles. This rapid growth relieved the State Bank of much of its commercial business, but it underlined its role as banker to the banks. The expansion relied on the State Bank for credit, and in 1912 the government slowed its pace by insisting that new banks pay between 25 and 50 per cent of their original capital to the State Bank.

  The outbreak of the war prompted a massive withdrawal of deposits.92 Thus the State Bank, while simultaneously addressing the needs of the Treasury, was also required to support the commercial banks. Some of the deposits withdrawn from the credit houses were reinvested in the State Bank. But in the month between 14 July and 14 August the State Bank’s accounts showed an increase in bills and other securities from 521.8 million to 963.8 million roubles, 425 million of which were deposited after the outbreak of the war.93 Thereafter the position stabilized. Funds were reinvested, and by January 1915 deposits were approaching their pre-war levels. But the commercial sector was slow to extend credit to industry. Lending remained below its pre-war level throughout the second half of 1914 and all of 1915. Not until 1916 did this aspect of banking activity revive. Thus, the war industries too turned to the State Bank.

  In France, as in Russia, the central bank performed both commercial and state functions. But the burdens on the Banque de France were that much greater than they were on the Russian State Bank, undertaken as they were in the context of overt confusion in public finance, compounded by a particularly fierce moratorium.

  However, France was like Germany in one respect. The experience of 1870 determined the obligations imposed on the Banque de France in the event of another war. Then the bank had been relieved of its obligation to redeem notes for currency, and had made advances to the state in the shape of an increased note issue. On 11 November 1911, in the aftermath of the second Moroccan crisis, Lucien Klotz, the finance minister of the day, put these principles into more concrete form. Convertibility would be suspended. The Banque de France was to advance the government 2,900 million francs. As security, the bank would receive treasury bills, paying 1 per cent interest, with an initial life of three months but renewable. Five hundred million francs of the advance would be immediately distributed throughout the country as credits to fund mobilization. To meet the anticipated demand for small change, the bank prepared a supply of 5-franc and 20-franc notes. On 30 November 1911 a comparable arrangement, this time for an advance of 100 million francs, was reached with the Bank of Algeria.94

  The end of July 1914 found the Banque de France, unlike the government, in a financially healthy position. Its concentration of gold gave it a 69 per-cent cover on a note issue of 6,800 million francs. France did not require its central bank to have a fixed gold reserve. But public confidence in the bank and its notes was amply justified by a perusal of its accounts. In addition to its 4,141 million francs in gold it held 625 million francs in silver, 1,373 million francs in Paris securities, 1,071 million francs in its branches, and 744 million francs in advances on shares. Its active balances, therefore, totalled 7,954 million francs, against notes actually in circulation of 6,683 million.95 In addition, France had healthy overseas balances, and further gold—to the tune of 4,500 million francs—in private hands.96

  The public’s faith in the bank, however, was not matched by its faith in the nation’s capacity to organize itself for war. Between 27 and 31 July 1,500 million francs were withdrawn from the banks.97 In Pau savings banks withdrawals rose fourfold on 27 July, sixfold on the 28th, and twentyfold on the 29th.98 On 30 July the savings banks limited withdrawals to a maximum of 50 francs every fortnight. On 31 July a one-month moratorium was imposed on all trade settlements. The interest rate was raised from 4 per cent to 6 per cent on the same day. But the banks were complaining that they were rich in paper and poor in specie. So, on 1 August they too became subject to a moratorium. On 5 August convertibility was suspended. On 6 August withdrawals on deposits were limited to a maximum of 250 francs and 5 per cent of the balance. On 9 August the trade and banking moratoriums were combined. On 14 August a moratorium was imposed on rents. Six days later the bank rate was lowered to 5 per cent. But further moratoriums followed. On 30 August all local-government bodies were relieved of the obligation to redeem debt, and on 23 September they no longer had to pay inte
rest or dividends. On 27 September insurance companies became subject to a moratorium, although most had already been postponing premiums for the previous six weeks.99

  Many of these moratoriums could be justified, at least temporarily, because of the confusion created in financial transactions by the operations of war. Those living in occupied areas could not remit rent to those residing elsewhere in France; war-related damage to property would require assessment and arbitration. And there was the threat to Paris itself. Many banks had decamped along with the government, and could not be traced by their account-holders. Between 18 August and 3 September 36 million francs in silver, 4,000 million francs in gold, and 14 million francs in share certificates were removed from the capital to the south-west.100

  But on 24 November 1914, when the situation had stabilized, the government, instead of removing the moratoriums, announced that they would continue until the end of the war. Although that in Algeria was lifted in March 1916,101 in metropolitan France they persisted until December 1920. Of course there were modifications. On 16 August 1914 war ministry contractors were allowed funds to buy raw materials or to pay wages. However, there was no provision for investment in new plant, and on 29 August their right of withdrawal was modified to the extent that they received advances direct from the state.102 The same decree on 29 August charged debtors with accrued interest and therefore encouraged them to settle if they could. The maximum withdrawal from a deposit was raised to 1,000 francs and 50 per cent of the balance by 27 October. But the net effect remained deadening for industry and for commerce. Employers could not buy raw materials and workers were not paid. Deposits flowed out but not in: the discount portfolio of the Crédit Lyonnais on 31 March 1915 was half its end-of-year total in 1913 (746 million francs as against 1,518 million), and its deposits had fallen from 913 million francs to 620 million. Nationally, all credit houses showed a decline in deposits from 7,500 million francs to 4,270 million in 1914.103 The total annual house rent that remained unpaid was reckoned to be 1,500 million francs.104 In the short term landlords confronted bankruptcy, but in the long run the calling in of the accumulated debt threatened tenants with penury.105 The bad debtor was protected, the creditor was not. The French economy carried an immense burden for the rest of the war.