To Arms

by Hew Strachan

  The bank’s loans took the form of an increase in note circulation. The maximum note issue, fixed at 12,000 million francs on 5 August 1914, settled at 40,000 million on 17 July 1919. Circulation rose progressively and evenly from 10,042 million francs at the end of 1914, to 13,216 million at the end of 1915, 16,580 million at the end of 1916, 22,336 million at the end of 1917, and 30,250 at the end of 1918.338 The total increase over the war as a whole, 533 per cent, was comparatively modest.339 Indeed, Keynes, in January 1915, felt that the Banque de France was being too conservative.340 The emphasis on holding gold, almost for its own sake, meant the cover for notes was still 42.4 per cent in 1917. Thus, note circulation seemed to be set more by the needs of commerce and industry than by state policy. But the fact that it increased in line with the government’s debt meant that for its critics the state was not as innocent as it claimed. In the first five months of 1918 circulation rose by 5,676 million francs, a rate of 247 million per week; one commentator averred that this was ‘the only financial practice of a government whose chief blessed heaven that he had not been born an economist’.341 By then too a major pressure for the increase in fiduciary circulation was the spending of the British and American armies, who purchased francs for pounds and dollars.

  Treasury bills were—alongside the bank’s advances—the other main method of French government borrowing in the early stages of the war. France used three main forms of floating debt. One, the advances of the trésoriers-payeurs généraux, was a revival of an earlier but dwindling practice. Two, national defence bonds and national defence obligations, were similar to the treasury bills used by other nations but were given more catchy titles to reflect the immediate needs of the state.

  The advances of the trésoriers-payeurs généraux were effectively mortgages taken out by the government on taxation revenue that had yet to come in. By 1914 these loans, paying interest of 1.75 per cent, had fallen to 30 million francs. Ribot tried to revive them in December 1914, setting the interest rate at 2.25 per cent. But, although the return eventually rose to 3.5 per cent, only 285 million francs were raised in deposits.342

  The most powerful competition to the advances of the trésoriers-payeurs généraux was national defence bonds. Before the war the ceiling on treasury bonds was fixed at 600 million francs, and the subscribers were banks and large companies. On 1 September 1914 the maximum was raised to 940 million francs, but only 350 million were in circulation. Ribot decided to rechristen them national defence bonds, and to invite public subscriptions. Paying 5 per cent free of tax, and sold in units of 100, 500, and 1,000 francs, for periods of three, nine, or twelve months, they proved immediately attractive. They functioned both as savings accounts for those looking for a hedge against wartime inflation and current accounts for those anxious to expand their businesses in wartime. They circumvented the constraints of the moratorium, they facilitated tax avoidance, and they did so against a background rhetoric of patriotic duty. They were fully subscribed by the end of November. A new maximum, of 1,400 million francs, was soon exceeded. National defence bonds raised 1,618.8 million francs in 1914, 7,985.8 million in 1915, 12,372 million in 1916,12,630.7 million in 1917 and 16,429 million in 1918. The monthly increase in circulation—576 million francs in 1915, 785 million in 1916, 912 million in 1917, and 1,400 million in 1918—is probably a better indication of their enduring popularity. On 31 December 1918 22,000 million francs were in circulation.

  National defence bonds were so easily convertible as almost to constitute currency; hence the importance of regular repayment if required so as to limit their inflationary effect. The Banque de France secured advances on the bonds of up to 80 per cent of their value. But, for all their importance in raising revenue the bonds were less successful in drawing in the deposits of small investors. Three-quarters of those subscribing in 1915 did so in blocks of 10,000 francs or more, and 34,692 subscribed for 100,000 francs each. For the rural smallholder, distant from a bank, the bonds’ short-term convertibility was less useful: most in this category subscribed for one year, and many did not subscribe at all. Thus, the multiplication of types of unit available, not only upwards to 10,000–franc and 100,000–franc denominations but particularly downwards to 5and 20-franc investments, was not as significant as might at first appear. In June 1918 the bonds were offered for periods as short as one month. By then the full 5 per cent was payable only on one-year investments; one-month bonds paid 3.5 per cent, three-month bonds 4 per cent, and six-month bonds 4.5 per cent. The disparity in interest rates was to some extent evened out by the price of issue, which for a three-month bond at 98.75 was closer to par than a one-year bond at 95.343

  The success of the national defence bonds was both a blessing and a curse. The blessing consisted in France’s success—at least compared with the other belligerents—in mobilizing the wealth of the public. Elsewhere almost all treasury bills and much of the war loan were taken up by financial institutions; in France most of the war loan and many of the treasury bills were held by private investors. The danger was the product of the very attractiveness of the national defence bonds: they were too nearly liquid. Little of the floating debt was fixed: between 1914 and 1919 76,000 million francs were raised in short-term debt and only 24,000 million in long-term. Furthermore, as the war ended Klotz loosened, rather than tightened, an already relaxed fiscal hold: 54,000 million francs of the short-term debt were issued between 1916 and 1919.344 France’s position seemed far more perilous than Germany’s.345

  What worried the government was less the spectre of inflation and more the fear that all its creditors would call in their debts at the same time. Ribot’s intention was to consolidate far more of the debt represented in national defence bonds than actually proved to be the case.346

  His first attempt, in January 1915, was to offer a series of ten-year national defence obligations at 96.5, paying 5 per cent interest free of tax. But the obligations failed to strike a chord with either the business community (who were reluctant to forfeit liquidity) or the public (whose enthusiasm was not encouraged by the obscure and complex methods of purchase). A second series was issued in February 1917. The five-year obligations were offered at par but paid a 2.5 per cent premium on maturity, and were thus designed to be held as investments until then.347 They enjoyed no more success.

  Initially Ribot was very reluctant to launch funded war loans. The evacuation of the government to Bordeaux, the desperate military situation, the closure of the bourse, and the effects of the moratorium—all militated against a successful issue in 1914–15. Most immediate was the effect of all these circumstances on the absorption of the 805 million franc perpetual loan (rente) issued at 3.5 per cent on 7 July 1914. The loan, intended to cover the equipment implications of the three-year service law, was nominally forty times oversubscribed. But it had been offered at a reduced price to institutions which then planned to pass it on to private clients at a profit: the outbreak of the war had checked this flow, requiring the institutions to pay the government but preventing the onward transmission to private investors. Thus, the credit houses were immobilized. By the end of August 1914 the price of the rente had already fallen from 91 to 82, and over half of the total had yet to be paid. The government was obliged to rescue those who had speculated on its stock if it was to free the market and guarantee its own credit. On 11 September 1914 it admitted the principle of conversion at the issue price provided the seller subscribed to future loans; it also used Banque de France advances to buy up the stock. By February 1915 all but 30 million francs of the target had been realized. The way was now open for the launch of the first public war loan.348

  Ribot’s rescue package had effectively committed France to a policy on war loans that followed the dictates of prestige and propaganda ahead of those of fiscal prudence. To ensure success all four of France’s war loans were offered at rates well below par, with high levels of interest and free of tax. The first and second loans (those of 1915 and 1916) were issued at 88; the third
(1917) was offered at 68.6 and the fourth (1918) at 70.8. Low initial prices guarded against a fall in values and encouraged investment for capital growth. However, the effect for the state was a decline in short-term revenue and an increase in future debt. The necessary corollary of such a policy ought to have been a low rate of interest. But France paid 5 per cent on the first two loans and 4 per cent on the last two.

  This triumvirate of government forfeits was justified by the need to consolidate the floating debt. The right to convert short-term stocks to long-term issues was fundamental to the purpose of the scheme. But in fact much pre-war debt, as well as all four war loans, were in the form of perpetual rentes. And yet conversion from these as well as from national defence bonds was permitted in at least some of the war loan offers. Effectively, a fourth inducement was granted—the opportunity to transfer an existing long-term investment to yet more advantageous terms. For the state, the advantage in popularizing the rentes lay in the right of the government to choose when to repay its debt. Thus, it could stage its payments and so spread the burden; it could time redemption for when the price was low; and it could postpone it for so long that depreciation had eliminated the differential between the issue price and par.

  The first war loan was launched in November 1915 and marked a definitive step to longer-term financial planning for the war. Individual subscribers totalled 3,133,389. Of 13, 308 million francs raised, 6,285 million came in cash and 2,244 million in national defence bonds; the rest—national defence obligations, 3.5 per-cent 1914 rentes, and the pre-war 3 per cent rentes— represented existing long-term debt that was traded for more favourable terms. For the second loan, floated in October 1916, payments in instalments could be extended over six months, and pre-war 3 per-cent rentes were not convertible: it thus constituted a drive to draw in cash and national defence bonds. Of 10,082 million francs contributed, 5,425 million were subscribed in cash and 3,693 million in national defence bonds; 956 million came from national defence obligations; and just under 8 million from 3.5 per-cent rentes.

  The profile of the third loan, opened on 26 November 1917, was remarkably similar—partly because Klotz set a target of 10 million francs, arguing that the length of the war now required regular, staged subscriptions rather than unlimited but less frequent drives for as much money as possible. Klotz put aside a small fund to enable the government to intervene in the market so as to keep up the price of the stock. The fourth loan, first offered on 20 October 1918, did not close until 24 November, and was dubbed the ‘liberation loan’. Unlike the third, it was unlimited, and 7 million individuals subscribed 22,163 million francs— including conversions of 239 million francs of Russian government stocks.349

  The relative success or failure of France’s war loans policy can be measured in different ways. It never fully caught up with its late start: pundits in 1919 reckoned that France was two years behind on its loan issues. Their nominal yield—55,600 million francs—was reduced to 24,000 million net when allowance is made for the conversion of existing stocks.350 Thus, they paid for a tenth of France’s war expenditure, and their effective contribution was only a third that of national defence bonds. On the other hand, the issues never developed the institutional reliance on the banks characteristic of Austria-Hungary, Italy, and Russia. This is not to say that public subscription embraced large numbers of small investors. French sources are coy as to how many individuals subscribed to the second and third loans: the implication is that there were fewer than to the first. In the industrial area of Le Creusot subscriptions fell successively over the first three loans.351 The average gross contribution per Frenchman in metropolitan France to all four loans was 1,405 francs; by contrast his compatriot in Algeria subscribed 1,633 francs.352 The crux was the big private investor. Tax exemptions encouraged the very wealthy to advance more, and from 1917 the government accepted loan stock in payment for the war profits tax.353

  France’s management of its borrowing was, by the standards of pre–1914 financial orthodoxy, relatively cautious. It restricted its note issue as best it could; it fought to conserve its gold; its devices for domestic debt drew in privately owned deposits. By these criteria it should have been in a far stronger financial position after the war than Britain. Britain’s total circulation in the war increased 1,154 per cent354—double France’s and even slightly more than Germany’s; it argued that gold was to be used, not hoarded; and it issued only three war loans, of which the first was directed at the banks and the last was offered as early as January 1917. Its annual average rate of borrowing as a proportion of its 1913 national income was, at 57.3 per cent, not significantly less than Germany’s 62 per cent.355 By the end of the financial year 1918/19 its total internal debt was £6,142 million, almost a tenfold increase on the national debt as it stood at the beginning of the financial year 1914/15.356 Interest payments on the debt rose from 9.6 per cent of budgeted receipts in 1913/14 to 22.4 per cent in 1920/1.357 And yet Britain escaped the levels of inflation suffered by either France or Germany after the war.

  It started the war with its debt at a historic low, and thereafter the sophistication of Britain’s financial structure enabled it to withstand better the effects of wartime liquidity. Its patterns of borrowing—and indeed its sources of revenue as a whole—were much more diverse than those of other belligerents. It found it easier to change tack in its policies, and it was readier to do so. As the world’s financial centre, London possessed a money market of greater sophistication and greater confidence. These qualities were important in enabling Britain to export its debt, to sell its stock overseas. Hence, much government debt did not enter the domestic banks’ secondary reserves and so did not fuel the note issue; hence too, much of the interest paid by the government went to fill the pockets of overseas investors, so stoking inflation elsewhere rather than feeding monetary overhang at home.358 But in addition, the confidence in Britain’s credit which reinforced the marketability of its stock elsewhere, and especially of course in New York, was also an important element in enabling the absorption of government debt at home. The maintenance of the gold standard, however fictional in practice, may have had its most potent effects on the sterling-dollar exchange, but it was also a symbol of financial strength to investors in Britain.

  The most obvious illustration of these points was the management of the increase in Britain’s circulation. In June 1914, of a total circulation of £199 million, £161 million was in coin. By June 1918 £148 million was still in coin: an underpinning of hard currency was thus preserved. The significant change was, of course, the rise in note issue, from £38 million to £311 million over the same period. However, the impact of this expansion was diffused by the fact that it was accomplished in large part by the use of treasury notes. They were payable in gold, but because they had the imprimatur of the government their convertibility mattered less to the public than did that of banknotes. Initially the commercial banks made only limited use of them: authorized to accept the equivalent of 20 per cent of their deposit liabilities, a total of £225 million, they actually took only £13 million. Treasury notes entered the circulation, therefore, not in a flood but in a steady trickle. Government payments for contracts were their most obvious route. As the quantity increased so their issue was secured less by the gold reserve, which settled at £28.5 million in June 1915, and more by government securities. In August 1915 the ratio of gold to currency notes was 61 per cent; in August 1918 it was 16.9 per cent and, of £168.5 million in outstanding notes, £141.6 million were backed by government securities. Currency notes, therefore, freed both the government and the note circulation from the disciplines of the Bank of England. The government’s credits were secured by loans, and it then transferred its credits back to its creditors so as to enable them to exchange the credits for the legal tender which the government also created. As long as no treasury notes were withdrawn, cash reserves increased in step with the government’s borrowing.

  The inflationary implications were immense.
But two factors dampened their effects. The first was that, after the initial surge of liquidity on mobilization, the total circulation remained comparatively steady until 1917. The increase in the note circulation between 1915 and 1917 was offset by the withdrawal of £35 million in gold, and the total circulation rose by £56 million between June 1915 and June 1916, and by £42 million between June 1916 and June 1917. Not until after the summer of 1917 did the growth in the money supply again rise steeply. The pressures for cash included the desire to evade the excess profits duty, the need (as a result of inflation) for notes larger than £1 or 10 shillings, and the reluctance to use cheques after they became subject to stamp duty. Between June 1917 and June 1918 £98 million were added to the total circulation. The major increase, though large, was late.359

  The second prop to domestic confidence in the note issue was its quarantining of the Bank of England. The beauty of treasury notes was that they ensured the liquidity required to fuel the war economy without impugning the status of the Bank of England’s own currency or its gold reserves. Although the Bank act was suspended in 1914, the first major pressures on the Bank to increase its issue were not felt until 1917. By then the ultimate source of legal tender was no longer the Bank but the Treasury.