Economics and the Public Welfare. Benjamin M. Anderson
of goods to Europe was offset by purchases made in the foreign exchange market, with dollars provided by these loans. J. P. Morgan & Company acted as the principal agent to the British and French governments in these exchange transactions.
The purpose of these continuing loans was to give our Allies in England time to set their houses in order to meet the shock of demobilization and to feed their people while the process of demobilization was being put through. A further purpose was to enable them to meet their commitments to American manufacturers and others on canceled war contracts.
The 1919 Bretton Woods Experiment—Morgan Unpegs Sterling, March 20. On March 20, 1919, the announcement was made that J. P. Morgan had unpegged sterling and would cease to make the purchases needed to sustain the rate. Sterling promptly broke, and all the other European exchanges broke. This was the end of the first phase of our Bretton Woods experiment following World War I. From the Armistice on November 11, 1918, to March 20, 1919, we did precisely what the International Monetary Fund under the Bretton Woods legislation is expected to do, namely, we stabilized the exchange rates of our European allies with funds drawn from the United States Treasury.
The second phase following March 20, 1919, represented continued support, though not absolute stabilization of these exchange rates with funds drawn from the United States Treasury until the loans ceased with June 30, 1919, and for a little time further until the proceeds of these loans were exhausted. The exports went on and the exchange rates went lower. But there came no backflow of goods from Europe. The continent of Europe had been so shattered by the war that it was not going back to work. It was living on imports received from the outside world. Public finances were out of hand, fiscal deficits were growing. The Continental governments were relying increasingly on loans from the central banks of issue, which were printing banknotes to cover governmental expenditures. Currencies were in disorder. As long as the outside world would take these currencies, Europe could buy imports and live upon them. Weak finance ministers had no incentive to tax the people or to place funding loans while the outside world was giving them such generous credits.
In the autumn of 1919 Frank Vanderlip, then president of the National City Bank of New York, returned from Europe where he had made a rapid but pretty fundamental survey, and, in an address at a public dinner in New York, gave an explanation of what was happening on the other side. His
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diagnosis was correct. His prescription was very inappropriate. His proposed remedy was that we should loan the European governments a billion dollars. But we had just loaned them nearly $3 billion since the Armistice and it had done little or nothing toward rehabilitating them. Much more fundamental remedies were needed. It is the duty of a lender to an embarrassed debtor to see to it that the debtor mends his ways and reorganizes his affairs so that the loan may be a good loan. We were lending to Europe overgenerously, but we were not performing the duty of a lender with respect to these other matters. Had we from the beginning insisted that the governments of Europe which received the loans from us should set their financial houses in order and straighten out their currencies as a condition for the loans, we should have accomplished a great deal with the loans. The governments later had to do it under much less favorable conditions and after the financial disorders had progressed much further.
The month of June 1919 represented the climax of our exports. In that single month we exported over a billion dollars’ worth of goods. In that single month we had an export balance of $635 million, of which $601 million represented our excess of exports with Europe alone. The exports continued, however, month after month in enormous volume. Goods were going not only to England, which was solvent and strong, but also to France, Belgium, and Italy, which were slipping badly financially, and in great volume also to Germany, which was going to pieces financially. How were they being paid for? Who was standing the risk of these shipments? Who was providing the money?
Sterling Goes Down with the Continental Exchanges. A clue came in one strange fact—England alone among the European belligerents had her financial home in order. England alone was showing industrial revival. And yet sterling exchange was weakening rapidly along with the other exchanges. That the foreign exchange markets should reflect the internal financial weakness of France, Belgium, Italy, and Germany was reasonable. But that sterling also should be going low, despite the strong financial and industrial position of England, called loudly for explanation.
London Stands Between United States and Continent. A careful study of the actual operations in foreign exchange in the late summer and autumn of 1919 revealed the fact that while there were enormous holdings of sterling in New York, there were very small holdings of francs, lire, and Belgian francs and of the other Continental exchanges, except for German marks. German marks were being bought by a great many speculators in the United States, by a great many people who had never before speculated in foreign exchange. But there were small accumulations of the other Continental exchanges. The market in New York for these Continental exchanges was narrow. Large sums could not be sold in New York without a break in price. The good market was in London, and New York banks and other exchange dealers buying francs, lire, Belgian francs, Greek drachmas, and so on, promptly resold them in London.
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London had long been the center for international speculation. In the days before the war there were always active speculative markets in London for practically anything: elephants, ships, beeswax, carved ivories from China, paintings of old masters, to say nothing of standard commodities, foreign exchange, stocks and bonds, and the like. A large body of London speculators stood ready to buy virtually anything at a concession in price. London banks, relying on the active speculative markets which made all manner of things liquid, were ready to finance, and did finance, these speculative transactions. London was usually safe in this, since London was full of experts who knew where the proper outlets were for all manner of unusual commodities, securities, or bills of exchange. After the Armistice London revived this speculative activity, so far as foreign exchange was concerned, on a great scale.
The Dove from Noah’s Ark. Ordinarily such speculation had been safe because the London speculators knew their outlets. In 1919 and 1920, however, there were no outlets for any large quantity of Continental exchanges. The outside world did not owe money to France, Italy, or other belligerent countries of the Continent on net balance and consequently had little need for Continental exchange. London was thus placed in a difficult position. She could keep the mass of Continental exchanges moving through active speculation. She could move them about through Switzerland, Paris, New York, and other centers. But, like the dove that Noah sent out from the Ark, they found no resting place for their feet, and they returned to London.
The magnitudes grew, moreover, as London found it necessary steadily to buy the new exchange continuously being created in order to protect the price of what she already held.
New York-London Rate Becomes New York-European Rate. The explanation of the decline in sterling along with the other exchanges is thus to be found in the fact that the London-New York rate had in effect become a Europe-New York rate. London was interposing her vast financial strength and prestige between the stricken Continent and the United States. In part, as suggested in the foregoing, this was unintentional, but in large part it was intentional. London was not merely buying Continental exchanges and holding them in growing volume, she was also making great extensions of credit to the continent of Europe and she was buying from the United States in order to sell on credit to the continent of Europe.
On a great scale strong business houses, particularly export and import houses in England, were borrowing from New York banks on the guarantee of British banks, and British banks of first rank and undoubted solvency were large direct borrowers from New York banks and, for that matter, from large banks in other great American financial centers.
Exports Go on Unfunded Credits—Bank Expansion, 1919-20. The exports were going on the basis of unfunded credits. Government credits had ceased. Private credit took its place. Long-term credits had ceased. Unfunded
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credits took their place. American exporters were giving long credits to European buyers, were selling on undated open accounts. They were tying up their working capital