To Arms

by Hew Strachan

  The publicly issued war loans could not in these circumstances be used to redeem the advances made by the Austro-Hungarian Bank. Rather, they were spent directly on the procurement of war-related goods. Short-term debt was not consolidated; instead, it was renewed and extended.306

  Although the watchword of the dual monarchy became ‘the war finances the war’,307 Vienna was slower off the mark in issuing its first loan than Berlin. The moratorium made it difficult for those with assets to get access to them; domestic liquidity remained low until government spending entered circulation; and the military victory required for a successful flotation proved stubbornly slow in coming. Despite the continuing lack of the latter, the exhaustion of credit and the return of liquidity led to the first war loan in November 1914. In Austria the stock was offered at 97.5, paying interest of 5.5 per cent, and redeemable in 1920. In Hungary the price was 96.5 and the interest rate 6 per cent. No upper limit was set. Austria raised 2,153.5 million crowns and Hungary 1,184.98 million.

  The banks agreed to lend against the collateral of the war loans at the current discount rate to 75 per cent of their face value. On this basis the loans were an attractive proposition. The continued closure of the stock exchanges shut off other avenues for speculation, and borrowing from the bank to lend to the state would show a profit. However, the effect was to draw in capital rather than income. Industrial investment was therefore undermined. Efforts were made to encourage the small subscriber: the lowest denomination was 100 crowns, and units of 25, 50, and 75 crowns were offered through post offices. But the principal element in the subscriptions were advances of between 10,000 and 50,000 crowns. The lenders were drawn disproportionately from Vienna, the Alps, Bohemia, and Moravia—and in Hungary from the Magyars. Thus, despite the apparent success of the first loan, it already lagged behind the increase in circulation; and its claim on patriotism showed that feeling to be as unevenly distributed as the empire’s private wealth.

  The first three Austrian loans were issued as treasury bills, the maturity extending to ten years on the second and fifteen on the third. However, the fourth loan, framed in April 1916, offered a choice between a forty-year bond at 93 or a seven-year bill at 95.5, both paying interest at 5.5 per cent. The aim was, of course, to reduce the short-term debt and dampen domestic liquidity. Small savers—those investing in 100-crown units—constituted 258,000 of the loan’s subscribers, as against 55,000 for the first issue. But the institutions were reluctant to commit funds for so long a period. As Austrian finance minister, Spitzmüller despaired of the commercial banks: ‘I had to consider myself lucky if I succeeded in the conversion of at least one of the earlier war loans.’308 And in subsequent loans the banks became the dominant element. Having taken 40.6 per cent of the first loan, they subscribed to 58.5 per cent of the eighth and last. They did not retain the stock which they acquired but quickly rediscounted it. Thus, the war loans were achieving neither of their principal fiscal roles—they were not absorbing privately held cash, and they were not shifting floating debt into long-term borrowing.

  Austria’s eight loans netted a nominal 35,129.3 million crowns. Hungary floated thirteen government loans, seven at 6 per cent and the others at 5.5 or 5 per cent, and a further four through the banks: they raised 18,851.8 million crowns. The greater frequency and better rates of Hungary’s issues helped explain its lesser dependence on the Austro-Hungarian Bank. The ratio of sums raised between the two monarchies was in line with their budgetary relationship—64.7:35.3. But Hungary floated its stock on the Austrian market, and therefore added 3,200 million crowns to the burden borne by Austria.309 Of the Austrian loans, the seventh, which totalled 6,045.9 million crowns, was nominally the most successful. In terms of real purchasing power, however, only the third raised more than the first; the seventh was worth 41 per cent of the first, and the eighth 24 per cent.310

  The fragility of Austria-Hungary’s economic and industrial development confronted it with irreconcilable demands in its credit operations. It might have soaked up more note issues if it had raised interest rates. But it was pathetically anxious not to divorce itself from the patterns adopted by the other banks of Europe. Only too aware of its own underdeveloped money market, it mortgaged its short-term position in the hope of retaining its postwar status. But, even if the Austro-Hungarian Bank had increased its discount rate, the effect might well have been either neutral or nugatory. The war needs of the state were so insistent as to overwhelm the deflationary effects of any interest rate, however high. And ultimately, higher rates would only have added to the burdens of war finance already borne by the dual monarchy.311

  Of the Entente powers, Russia’s position was that most akin to Austria-Hungary’s. Its banking system and money market were underdeveloped. The profits to be gained by the quick turnover of goods in a depreciating currency encouraged the growth of middlemen and caused the banks to be bypassed. These factors accelerated circulation. But, unlike Austria-Hungary, hoarding then had a dampening effect. Peasants reverted to type and simply opted out of the cash economy; one estimate has calculated that perhaps half the total note circulation was hoarded.312

  The corollary of hoarding in Russia was the failure of the publicly issued war loans to draw in privately held funds. Russia issued seven war loans between November 1914 and March 1917. Most had a fifty-year life (the seventh was to run for fifty-five years) but could be redeemed after ten years. The first was offered at 95 and paid 5 per cent. It totalled 466.6 million roubles. The third, issued in May 1915, brought the price up to 99, but in return paid 5.5 per cent interest over the first six years and 5 per cent thereafter. The fourth (November 1915), fifth (March 1916), and sixth (October 1916) combined both the inducement of a low price, 95, and the higher interest rate of 5.5 per cent. The seventh, the so-called Liberty Loan issued by the Provisional Government, brought the interest rate down to 5 per cent, but went on sale at 85. This provided a total annual yield to the investor of 5.88 per cent (as opposed to 5.318 for the first loan), and brought in the highest nominal subscription, 3,841.4 million roubles. The combined proceeds from the seven loans were 11,378,289,000 roubles against a theoretical target of 12,010,000,000.313

  The lowest unit offered in the first loan was 50 roubles. As elsewhere, press and propaganda campaigns tried to lure the small investor. The subscription period was extended from seven days for the first loan to forty-six for the fifth. But private individuals were reluctant to respond. The seventh loan was offered in units of 20, 40, and 50 roubles. The Provisional Government harped on its claims to popular support, and the soldiers’ and workers’ soviet hinted at more direct methods. But by July 1917, after three months, only 2 per cent of the Petrograd population and 4 per cent of Moscow’s had subscribed.314

  The success of the loan issues, therefore, rested with the banks. They took about three-fifths of the first two issues, and about half overall. Their commission—3 per cent at first, and 2 per cent on later issues—was high, and substantially reduced the total yield. Many of their subscriptions were in the form of paper securities. By December 1915 the State Bank’s advances on paper reached 877 million roubles, and by May 1917—after a lull in 1916—topped 1,000 million roubles. The State Bank itself thus kept its own holdings of paper relatively constant, while the government found itself rediscounting existing government debt rather than clawing back circulating cash.315 Indeed, the effect of the banks’ involvement was to increase circulation, not reduce it. The savings banks drew in money that its owners intended to hoard, and which would therefore have been withdrawn from circulation. But by subscribing to war loans they put this money back into the hands of the government, who then spent it and so restored it to circulation.316

  The actual note issue effectively doubled in each year of the war. From 1,633.3 million roubles at the end of July 1914, it rose to 2,946.5 million at the beginning of 1915, 5,617 million at the beginning of 1916, and 9,097.3 million at the beginning of 1917. By November 1917 and the Bolshevik revolut
ion 18,917 million roubles were in circulation. The impact of mobilization and then of the Provisional Government’s policies can best be illustrated by the average monthly issue, which hit 310.4 million roubles after the outbreak of war in 1914, but fell in 1915 and 1916, only to rise after March 1917 first to 1,083 million and then—by October—to 1,516 million. The state printing works could not keep pace, and the involvement of private firms eased the path to counterfeit production.317

  The State Bank’s note issue was secured on the collateral of 5 per cent treasury bills. The initial authorization for 400 million roubles in treasury bills had risen to 6,000 million by the end of 1915, 12,000 million by October 1916, and 25,000 million by October 1917. The actual amounts outstanding never reached these ceilings. The vast majority were taken by the State Bank: it held 82.4 per cent of the total in July 1915. Efforts were made to distribute the short-term debt more widely. The bills became increasingly negotiable, and advances on them of 95 per cent of par at 5.5 per cent were authorized. The Provisional Government made payments in treasury bills for contracts, rising to 50 per cent of the total over 200,000 roubles. But although the State Bank’s holdings reduced to 65.3 per cent of all treasury bills in June 1916, they climbed back to 73.7 per cent in September 1917. Efforts to convert this floating debt into long-term loans were no more successful. The interest rate on the treasury bills was sufficiently high to drive out treasury bonds by 1915—the 4 per cent ‘series’, interest-bearing notes with a life of four years which circulated like currency, raised only 850 million roubles.318 By October 1917 48 per cent of Russia’s debt was in short-term treasury bills.319

  Russia’s borrowing, therefore, rested just as much as Austria-Hungary’s on an interlocking relationship between the government and the central bank. Of 38,649 million roubles of war expenditure, 16,426.5 million were funded through treasury bills, the majority of them lodged with the State Bank; of a further 11,408.2 million raised through domestic loans, over half was generated through the banks.320 But the short-term treasury bills held by the State Bank as collateral did not keep pace with the note issue held by the Treasury in exchange.321 Thus, the government’s debt was not even notionally covered by the credit-creating devices of the day. The issue of paper notes, over and above government borrowing, covered 31.1 per cent of war expenditure.322

  Italy’s story ought to have been similar—and in some respects was. The poverty of the population and the low level of national wealth both ensured that propaganda drives to urge small investors to subscribe to war loans would not prove particularly lucrative. Industry was urged to use its wartime profits to write off its own debts, not to buy government stocks. Thus, as in Russia, the state looked to the banks. But the inflationary implications were kept in check by relatively low levels of liquidity and by the consolidation of a higher proportion of the total borrowing in long-term debt.

  Italy’s first war loan was floated before it entered the war, in January 1915. Its arms spending prompted an issue of 1,000 million lire in twenty-five-year obligations, offered at 97 and paying 4.5 per cent in interest. Only 881 million was subscribed—a reflection, it was argued, of public support for Italy’s neutrality. But in any case, the terms of the loan were not particularly attractive and the financial community proposed to wait until the government came back to the market with a better offer. A banking consortium, headed by the Bank of Italy, which had underwritten half the issue had therefore to produce the shortfall, 119 million lire. By late May 1915 the price of the stock had fallen to 95.32.

  The concessions to experience in the second war loan, issued in July 1915, were minimal. The only change in the terms was the reduction in price from 97 to 95, and for subscribers to the original loan to 93. Once again the banks had to come to the rescue—underwriting 200 million lire and making loans of up to 95 per cent of the amount subscribed. A total of 1,145.8 million lire was eventually raised, but by the end of September 1915 the price was 93.92 and falling.

  The terms of the third loan, in January 1916, were more attractive: a price of 97.5 at an interest rate of 5 per cent produced a real return of 5.13 per cent per annum. The target figure of 1,500 million lire was exceeded. Pre-war treasury bonds were accepted for up to half the total; most of the first and second war loans were converted. A total of 3,018.1 million lire was raised, 891.4 million of it in securities. But again the price fell: in October 1916 it stood at 93.7.

  The fourth war loan, that of January 1917, was a perpetual rent, and the government stated it would not be converted for fifteen years. Issued at 90 and paying 5 per cent interest, it raised 3,798.5 million lire, a third of which represented conversions of earlier stocks. Initially the price rose, but by June it had settled below 90. The final wartime issue, in January 1918, was offered in the aftermath of Italy’s defeat at Caporetto. The banks thought 2,000 million lire a realistic ceiling, but Francesco Nitti, the finance minister, was determined to engineer a propaganda and political triumph out of the loan drive, and set a target of 6,000 million. By dint of extending the subscription period to March, and of offering life insurance policies against subscriptions, he succeeded. Two-thirds of the total was raised in cash, and one-third in securities.323

  As elsewhere, the banks’ support of the war loan issues provided the basis for the expansion of credit rather than for the absorption of cash. Industry was encouraged to take on loan stock; from October 1915 contractors could be paid in treasury securities; and from January 1918 firms could treat their loan subscriptions as capital exempted from war profits tax.324 But having acquired the stock, companies rapidly disposed of it. Hence the fall in prices, which hit—and in due course deterred—the small investor. The government’s securities were therefore taken on by the banks as collateral, so expanding their commercial portfolios. In December 1918 approximately 2,800 million of 10,845 million lire in treasury paper securities were held by the four largest commercial banks.325

  But what was significant in the Italian case was that this process took root relatively late in the war. The first three war loans caused an expansion of credit as investors borrowed to subscribe to the issues, but contraction followed as banks called in their debts and as the stock price fell. Not until 1917, as the institutional share in the high targets increased, did the expansion of credit fail to fall after the issue of the loan.

  Furthermore, the proportion of short-term debt to long-term also remained relatively low until late in the war. In 1914 5.59 per cent of the national debt was floating; in 1915 14.85 per cent; in 1916 15.6 per cent; in 1917 22.07 per cent; and in 1918 27.06 per cent.326 The major increase in floating debt did not occur until the summer of 1916. Between July 1916 and November 1917 almost 1,000 million lire were advanced—in secret—by the Bank of Italy to the government on the security of low-interest treasury bills. In the twelve months after July 1916 short- and medium-term securities accounted for 58 per cent of all government securities (as against 20 per cent in the preceding year). But much of this was fixed in three or five year bonds, and much also was consolidated in the fifth war loan in 1918.327

  Both Antonio Salandra, Italy’s prime minister between March 1914 and June 1916, and the Bank of Italy pursued a policy of tight monetary control. The August 1914 crisis in the Italian case arose from the panic on the stock exchanges; falling prices for industrial shares hit the mixed banks that had financed industry, and undermined the value of the collateral held by the credit institutions. Salandra allowed only a small increase in note circulation, preferring to back the Bank of Italy’s wish for a moratorium. The Bank remained liable for tax on additional note issue. Furthermore, it feared that any government guarantees on the lines followed by London would enable the commercial banks to pass on their bad debts to the state. Thus Italy risked recession in 1914—which it evaded through the war-led boom—rather than inflation.328

  Italy’s total note circulation rose 504 per cent in the First World War.329 Between 1914 and 1919 the issue of the banks rose 618.75 per cent, and
the issue of state notes 355.08 per cent.330 The restraint of the government is evident in its handling of state notes, whose maximum, fixed at 500 million lire in December 1910, rose in steady but small steps to 2,200 million in November 1918. The main injection of cash came in the wake of Caporetto: the note issue expanded 23 per cent in 1914, 31 per cent in 1915, and 27 per cent in 1916, but 59 per cent in 1917 and 38 per cent in 1918. The total, which stood at 3,530 million lire on 31 December 1913, had by the end of 1916 doubled in three years, but by the end of 1918—after a further two years—had doubled again, amounting to 15,900 million lire.331

  France funded 83.5 per cent of its wartime expenditure through loans.332 In 1919 its debt charges were 7,900 million francs a year, the equivalent of 120 per cent of its income from taxation.333 By 1920 its internal debt expressed as a ratio of its national product was 1.64, as opposed to 1.26 for Britain and 0.27 for the United States. And yet its public debt grew more slowly in the war than did that of either of its western allies. This was a reflection of how high were the existing borrowings of the French government in 1914.334 France’s public capital was doubly immobilized at the outbreak of war—first by this debt and secondly by the moratorium.

  The vital role played by the Banque de France in ensuring liquidity during the mobilization persisted for the rest of the war. On 4 May 1915 Ribot signed a new convention, setting a ceiling of 9,000 million francs (in place of 6,000 million) on the bank’s advances to the government. In February 1917 the maximum was fixed at 12,000 million, in October at 15,000 million, in August 1918 at 21,000 million, and in June at 24,000 million. The Banque d’Algérie had advanced 75 million francs by December 1915, and contributed a further 45 million between then and May 1917, 80 million between May 1917 and January 1918, and 580 million over the last ten months of the war.335 The principle of state financial probity, enunciated by Ribot, was affirmed by regular repayments of the debt from the yields of publicly issued war loans: by the end of 1918 7,400 million francs of Banque de France advances had been redeemed in this way, and 8,850 million in all. But 4,650 million francs were still outstanding. The practice was absurd, as the repayments in turn required the government to come back for regular increases in credit. A mechanisim devised to surmount a short-term crisis became a funding method for conducting long-term war.336 These advances constituted 10 to 15 per cent of total receipts from all sources between 1914 and 1919.337