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2

The Outbreak of the War in 1914

The War Came as a Surprise to Most Informed Men. The war came as a great shock, not only to the masses of the American people, but also to most well-informed Americans—and, for that matter, to most Europeans. There had been no first-rate war since the Franco-Prussian War of 1870. Wars of limited objectives there had been, as the Spanish-American War of 1898 and the Russo-Japanese War of 1904-05. Colonial wars there had been, as the very important Boer War of 1899-1902. Intermittent fighting in the Balkans had existed, but the Balkans were looked upon as a special case. But a great war involving the major nations of Europe was looked upon as something so terrible, so catastrophic, and so dangerous to everybody involved that few expected it.

The present writer can recall only two men among those of his acquaintance for whose views he had high respect, who really anticipated that Germany would force the pace and precipitate world conflict. One of these was Dean David Kinley of the University of Illinois (later president of the university) who, in the winter of 1909-10, analyzing the tendencies in German thought and policy, expressed the opinion that these tendencies would make inevitably for war in the near future. The other was Franklin Henry Giddings, the great sociologist of Columbia University, who, a year or two later, after conversations with some visiting German professors, expressed himself as aghast at the rapid hardening of the German attitude and as feeling that an inevitable conflict was close at hand. But to most of the informed American public the outbreak of the war in 1914 was a bolt from the blue.

A Surprise to the Financial World—Premonitory Financial Phenomena. To the banking world and to the international bankers it came as a great surprise. There had been, indeed, financial phenomena which foreshadowed it. There had been accumulation of gold by Germany, Russia, and France. The first manifestation came as early as 1912, as German bankers began to take steps to increase their gold supply. In order to take

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gold out of the hands of the people and carry it to the reserves of the Reichsbank, fifty- and twenty-mark banknotes were issued to take the place of the gold in circulation. German agents regularly appeared as bidders for gold in the London auction rooms. Gold was shipped from the United States to Germany, and the famous Spandau Treasure was transferred to the vaults of the Reichsbank. By 1914 Germany ceased to take much gold, having presumably decided that her resources were adequate.

France and Russia made strong efforts to increase their gold reserves during the spring and summer of 1914. In the eighteen months preceding the outbreak of the war the gold holdings of the central banks of Germany, France, and Russia were estimated to have increased by $360 million. The drift of gold to these great central reservoirs led to a tightening of the money markets of the rest of the world and to an unusually large drain on the gold supply of the United States.

Recognized by A. D. Noyes. Few, however, even among informed financiers, saw in this a forecast of war. One notable exception among American observers was A. D. Noyes, then financial editor of the New York Evening Post. In his annual summaries at the end of 1912 and at the end of 1913, he called attention to the pulling in of gold by European central banks under the apprehension of war, and explained the mild recession in business in 1913 in the United States by this phenomenon. Europe had ceased to lend to the United States and had begun withdrawal of funds. We had been accustomed to rely on European capital for part of the funds needed for our own business expansion. We were ceasing to get it and were repaying part of it. Our industrial pace slowed down because of this fact.

The Causes of the War. There are not a few writers, overimpressed by the economic interpretation of history and especially by Marxist versions of the economic interpretation of history, who have seen the war of 1914 as the result of inevitable economic tendencies. There is no one principle of historical interpretation and there are few, if any, inevitable economic tendencies. Political, moral, cultural, and religious forces are coefficients with economic forces in the determination of historical events, and the influence of outstanding personalities in strategic positions is often far more significant than any economic determinist will concede.

Views of Munroe Smith and Veblen. The two writers who seem to have explained the outbreak of the war in 1914 most clearly are Munroe Smith, professor of Roman law at Columbia University, and Thorstein Veblen. Munroe Smith’s explanation appeared in the Political Science Quarterly in March 1915 in an article called “Military Strategy Versus Diplomacy.” Munroe Smith had previously written a very interesting biography of Bismarck. In the article referred to he begins by saying that he assumes that he will not be accused of setting up utopian standards when he judges the course of German diplomacy immediately preceding the war by the standards of Bismarck. Bismarck had always respected the “imponderables.”

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Bismarck had had a wholesome respect for world public opinion. He had never gone into war without first seeing to it that his alliances were dependable, that neutral relations were assured, and that world opinion was on the side of Germany. He had sometimes used devious tricks in creating a favorable world opinion, as in his falsification of the telegram at Ems, but he had had a respect for the opinion of mankind, and he had compelled his generals to wait until public opinion was on his side. In the war with Austria von Moltke had pleaded with Bismarck to let him strike at once, saying that every day’s delay meant unnecessary military losses. Bismarck made him wait until the psychological atmosphere was right. By 1914, however, the diplomat in Germany was no longer in the saddle—the military strategist was in the saddle. Bethmann-Hollweg later admitted this.¹ It is not correct to say, Munroe Smith contends, that German diplomacy failed in 1914. The correct thing to say is that German diplomacy never had a chance.

Veblen’s explanation came in an unpublished manuscript in 1915.² Veblen pointed out that modern war cannot be successfully carried on except by a highly industrialized country. Modern war calls for immense mechanical equipment and for a continuing supply of mechanical equipment. But industrialization involves the growth of great cities and the bringing together of great masses of the population, taking them away from the control of rural nobles and landlords and bringing them together under new conditions which promote the growth of democracy. Industrialization and democracy in general grow together. But democracy makes for peace. The common man has nothing to gain from war. He will fight to defend his country, but there is no glamour for him in aggressive fighting against other countries. Primitive war often meant booty and women and adventure for the common man, but highly mechanized modern war has few attractions.

With industrial power and democracy developing together, it was thus to be expected that the countries powerful enough to precipitate war would be pacific enough not to do it. But Veblen noted two dangerous exceptions to this rule. The first was Germany and the second was Japan. In each of these countries industrial power had developed without the concomitant growth of democracy. In each of these countries political power was in the hands of an oligarchy. Though the common man would gain nothing from war, the oligarchy might gain and would gain from a successful war. Germany and Japan, therefore, were two countries to which the world might look to force the pace in upsetting international peace.

These two discussions seem to me to contain the most fundamental

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explanations of the rupturing of the peaceful world that came in 1914; and Veblen’s principle that industrial power in the hands of an oligarchy is a menace to the peace of the world is startlingly prophetic of the developments that have come in the 1930s. Democracy is pacific, dangerously pacific, as France and England and the United States demonstrated in the four or five years preceding the outbreak of the war in 1939. Woodrow Wilson had a profound insight when he said that we must “make the world safe for democracy.”

Only Vienna Bourse Makes Immediate Response to Assassination at Sarajevo, June 28, 1914. The assassination of the Austrian crown prince at Sarajevo on June 28, 1914, did not at once alarm the world. It alarmed Austria. There was immediate heavy selling of securities on the Vienna Bourse. Paris was preoccupied with her own economic and political problems and did not take the episode seriously, although there was recognition that the situation called for tact and decorum. Paul Leroy-Beaulieu, in the issue of L’Economiste Français next following the assassination, gave editorial expression of sympathy for Austria and her venerable ruler, Franz Joseph, with a degree of courtesy that makes one feel that he was performing an official duty.

Bourse Panics in Berlin and Paris, July 23. On July 20 Vienna had a further heavy decline in stocks. It was July 23 before Paris and Berlin had real panic in the stock markets. There had meanwhile been reflexes in the stock exchanges of London and New York. By July 25 selling in both markets on foreign accounts was very heavy. On July 27 the Vienna Exchange was closed. The next day Austria declared war on Serbia. Stock exchanges were closed on July 28 in Montreal, Toronto, and Madrid. On July 29 the Berlin Bourse discontinued. By July 30 the panic had reached London and bourses were closed in Saint Petersburg and all South American countries. The Coulisse (curb market) was closed in Paris that day. On the same day the Parquet, the official bourse of Paris, virtually suspended selling, although it was not officially closed until September 3, when the French government withdrew from Paris to Bordeaux.

London and New York Stock Exchanges Close, July 31. On July 31 the London Stock Exchange was closed, and five hours later (the difference between London time and New York time), at four minutes before ten—the time for the opening of the New York Stock Exchange—the authorities of that institution announced to the anxious brokers that it would not open. Enormous selling orders from Europe and other frightened markets had accumulated in their hands overnight, selling orders “at the market” (meaning at any price obtainable); and it was clear that New York alone could not stand the strain of the concentrated selling of a frightened world.

On August 1 Germany declared war on Russia, and late at night on August 4 England declared war on Germany.

Danger, Uncertainty, and the Rush to Liquidity. Selling on the the stock

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exchanges at the outbreak of the war was an illustration of a fundamental principle in economic life. When there is general confidence in the uninterrupted goings on of economic life, confidence in the legal framework under which economic life operates and in the essential integrity and fairness of governments, men with capital prefer to have their capital employed. They want income from it. They want capital to work with, as giving additional scope to their personal efforts and their personal abilities. They are quite content to have their capital embodied in physical goods destined for future sale, in shares in industrial undertakings, in real estate which brings in rentals, or in loans to active men engaged in industry and commerce. But when grave uncertainties arise, and, above all, when unexpected war comes, men prefer gold to real estate. The man who has his wealth tied up in lands can make no shift. He must sit and take what comes. With the apprehension of war, however, the effort is made to convert illiquid wealth into liquid form as rapidly as possible, even though heavy sacrifices are involved.

London Strong vis-à-vis the Outside World. London was the center for international payments in 1914, and London, like all financial centers, was hard hit. But in its financial relations with the rest of the world London was exceedingly strong. The world owed London. London did not owe the world. Foreigners held sterling balances in British banks, but, on a vastly greater scale, foreigners owed sterling on daily maturing quick obligations to the British money market.

For example, a French coffee importer in Havre buying coffee at Santos in Brazil would arrange with a London acceptance house to finance the transaction. The coffee would be priced, not in francs or milreis, but in pounds sterling. The Brazilian exporter would draw, not on the French importer, but on the London acceptance house, a ninety-day bill of exchange, attaching to it the documents giving title to the coffee. The London acceptance house would accept the bill and turn over the documents to the French importer, who would then get the coffee. The Brazilian exporter would discount the bill in the London discount market and would use the sterling proceeds in buying milreis, because he wanted milreis at home for his next turnover.

London would no longer owe anything to the outside world on this transaction, but the French importer would still owe the London acceptance house, within ninety days, the sterling with which to pay a London bank or discount house when the bill matured.

In general, in financing international trade, London advanced cash in exchange for short-term obligations, and the world, on balance, was indebted to London on short term in large amounts. This was the situation at the outbreak of the war. All the world owed money to London on short term, and maturities were coming every day. All the world needed pounds sterling with which to pay these daily maturing debts.

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But Internally Shaken—Weakness of Acceptance Houses. In the ordinary course of events new sterling in foreign hands would be steadily created by transactions similar to the one above described. But the outbreak of the war brought all these transactions to a sudden halt. First of all, with German cruisers on the seas shipments of goods were suddenly arrested. Second, with the shock of the outbreak of the war the position of the London acceptance houses, which had seemed invulnerable, suddenly showed great vulnerability. They had felt safe in giving acceptances up to several times their capital, counting on a steady inflow of funds to match their daily maturing obligations. But suddenly funds ceased to come to them. With the German armies invading France, the French importer of Santos coffee could not easily market his coffee, and even if he sold it for cash, could not certainly convert his francs into the sterling needed to send to the London acceptance house. The foreign exchange markets were suddenly demoralized. An acceptance house was certain that it could not collect the large amounts due it from Germany, and everywhere in the world disorders of one kind or another arose which placed the debtors of the London acceptance house in an awkward position. The acceptance houses were therefore entirely unable to give any more acceptance credits.

A further resource for obtaining sterling would normally be to ship gold to London, but this again, with hostile cruisers on the seas, was quite impossible. One great German ship, the Kronprinzessin Cecelie, had started out from New York for England and France just before the outbreak of the war with $10 million in gold, but had promptly turned back with the news of the outbreak of the war. The world owed London. The world could not pay in gold or in goods. The world could not get additional credit in London with the demoralization of the London money market. How was the world to pay?

Sterling Rises to $7.00. The first effect was a startling rise in the price of sterling. Men who had no option about paying their debts in London paid through the nose. Sterling rose from approximately $4.8668 to $7.00, though this $7.00 quotation represented only a few transactions in a nominal market.

Emergency Measures—Paris and London. Emergency measures of various kinds were employed in the principal centers. Paris was financially weak in any case. Prior to 1913 there had been many bad foreign loans placed in the French market through the great French banks: loans to Russia, loans to Latin America, loans to the Balkans. The weakness of the Balkan loans had been revealed during the Balkan wars in the two or three years preceding the outbreak of World War I. The weakness of the Brazilian loans and of Latin American loans in general had been revealed in the crisis that followed the collapse of the price of Brazilian coffee in 1913. With the outbreak of the war, moreover, France had the added complication that the German armies were beating their way into the richest of the

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French industrial provinces. The great banks of France were frightened and cowardly. They rediscounted their bills with the Bank of France and hoarded cash. The French bourse was demoralized. The Bank of France showed itself courageous and intelligent. Governmental intervention seemed clearly indicated, but governmental intervention went much too far. Debtors were legally relieved by moratorium from the payment of their debts when due, on a sweeping scale. Bourse transactions ceased, the giving and taking of commercial credits very largely ceased, and governmental credit was extended in many places where private credits had previously been used.

Governmental emergency measures in England were much more moderate, though some seemed necessary. The Bank of England came to the rescue of the acceptance houses, taking over from the Joint Stock Banks, the discount houses, the bill brokers, and other holders their outstanding bills. The government later gave the acceptance houses, as a means of restoring their power to function, a clean slate on which to write, in that new acceptances would have priority over the old acceptances as a claim upon their assets.

Emergency Measures—United States. The stories of London and Paris in 1914 are interesting.³ Chief attention is given here, however, to the way in which the shock was met in the United States.

No Government Intervention in United States. The American financial system met the shock with no formal government aid, although there was good cooperation and good understanding between New York and Washington. The closing of the stock exchange was decided upon by the stock exchange in conference with the New York clearinghouse banks. The banks had large loans made to stock exchange firms against stock exchange collateral. By informal agreement they refrained from calling these loans. These stock exchange loans the banks had ordinarily looked upon as one of their principal sources of liquidity. Any bank needing cash could call brokers’ loans, and the broker must pay before the close of the banking day. The understanding was absolute, and on strict brokers’ loans there was no question about it. The broker could get a loan from some other lender by paying the necessary rate of interest, or the broker could, if necessary, compel his customers to sell securities to pay off their loans to him so that he could pay off his loans to the bank. If the broker did not pay, the bank could sell the collateral on the floor of the stock exchange and turn over the difference between the face of the loan and the proceeds of the sale of collateral to the broker.

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Frozen Stock Exchange Loans. With the closing of the stock exchange, however, these loans were frozen, and were no longer a source of liquidity to the banks. It did no good to call the loan and try to sell the coliateral if there was no market. The banks contented themselves with seeing to it that the loans were properly margined. In valuing securities as collateral, the closing quotations of July 30, the day before the New York Stock Exchange closed, were taken.

The timing of the closing of the New York Stock Exchange was skillfully managed. There were some who had urged the closing a day or two before. It is the view of Professor O. M. W. Sprague and H. G. S. Noble, president of the New York Stock Exchange, that it is fortunate the exchange stayed open as long as it did. Stock prices went low, but not so low that the banks and the brokers could not stand the strain. The market was pretty thoroughly liquidated. The reopening of the exchange was then made much easier than would have been the case had stocks remained at a higher level with many sellers anxious to liquidate while the exchange was closed.⁴ The control over selling outside the exchange during the period while the exchange was closed would, moreover, have been much less effective had not the market been thoroughly liquidated. As Noble makes clear in his interesting paper, the closing of the stock exchange was accompanied by a rigorous control over auction rooms, the Curb and all other outside markets, and the volume of security selling was held within very narrow limits indeed during the period the stock exchange remained closed. The break in prices was pretty drastic, as shown by the following table:

NEW YORK STOCK PRICES

	High, 1914	July 30, 1914	Decline
Atchison	100⅜	89½	10⅞
Baltimore & Ohio	98⅜	72	26⅜
Brooklyn Rapid Transit	94½	79	15½
Canadian Pacific	220½	156⅛	64⅜
Chesapeake & Ohio	68	41½	26½
St. Paul	107⅛	85	22⅛
U. S. Steel	67¼	50½	16¾

These securities were favorites with Europeans, and they were subject to special pressure of foreign selling in the period that preceded the close of the stock exchange. But the declines were really a good deal less drastic than might have been anticipated. Our stock exchange in those days was pretty tough and resilient. The declines in the averages were heavy, but

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again moderate under the circumstances. Twenty-five typical railway stocks had an average price of 78.18 at the end of June 1914. They declined to 66.8 for their closing price in July. Twenty-five typical industrial stocks had a closing price of 58.19 in June 1914 and dropped to 48.76 by the end of July.

Break in Stocks Moderate in 1914 as Compared with 1937. If we contrast the break in security prices at the outbreak of the war in 1914 with the break in security prices in the governmentally regulated stock exchange of 1937, we may wonder whether governmental regulation designed to protect investors has proved itself an unqualified success. The high price for the Dow-Jones industrial average was 194.40 in the summer of 1937, and this dropped to 98.95 in the early months of 1938. The high for the Dow-Jones average of railroad stocks in 1937 was 64.46, and this dropped to a low of 18.00 in the early months of 1938. The investor was safer in the unregulated market of 1914 than when protected by the SEC in 1937.

Clearinghouse Certificates. In 1914 the New York banks, with liquidity suddenly impaired, though with assets which they trusted for the long pull, found themselves under unusual pressure to export cash. During the week ending July 31 the clearinghouse banks and trust companies of New York lost $56 million in cash reserve, of which $20 million represented withdrawals by American and Canadian banks. Resort was promptly made to the use of clearinghouse loan certificates, good between the banks, which had been used in New York also in previous extreme crises, namely, 1907, 1893, and 1873. These certificates were obtained by an individual bank through application to the Clearinghouse Committee. The Clearinghouse Committee would take the notes of the applying bank, secured by approved collateral with proper margin, and bearing interest of six percent. The clearinghouse certificate was the obligation of all the banks in the clearinghouse, and was acceptable to all of them in lieu of cash in settlement of clearinghouse balances. The bank which held the clearinghouse certificate received the interest which the borrowing bank paid. The clearinghouse certificate thus relieved the pressure on the cash resources of the weaker banks.

Aldrich-Vreeland Notes. In the three previous crises of 1873, 1893, and 1907 the New York banks had been obliged to restrict cash payments. We had in those years an inelastic currency, a currency which could not suddenly expand to meet emergencies or even to meet seasonal variations. It consisted of gold, silver dollars and silver certificates, United States notes (greenbacks), and national banknotes. Of these only gold could be increased, and a substantial increase of gold could come only through imports, impossible in the emergency situation of 1914 and slow in the crisis of 1907—at which time, however, the import of $100 million of gold from Europe did end the money stringency and permit the resumption of unrestricted cash payments.

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We were fortunate in having available a further remedy in 1914. The Federal Reserve banks had not yet begun to operate, and the shock had to be met without this assistance. But the Federal Reserve Act of 1913 had wisely saved and improved upon the provisions of the Aldrich-Vreeland Act of 1908, which had been designed to enable national banks to issue notes freely in a crisis. This act was to have expired by limitation on July 1, 1914. But Carter Glass, chairman of the House Committee on Banking and Currency, had had the foresight to have it extended for another year to provide against emergencies pending the inauguration of the Federal Reserve System, and had amended it by reducing the tax on notes issued under the Aldrich-Vreeland Act from five percent to three percent during the first three months of issue, thereafter increasing it one-half percent to a maximum of ten percent.

No use had been made of the Aldrich-Vreeland Act prior to this emergency. The very term emergency currency had been an obstacle. But at the outbreak of the war speedy resort was had to it and the new notes were issued in large volume. Of the 7,600 national banks, 2,197 became members of the “Currency Associations,” which issued these notes. The maximum amount of these notes outstanding was $386,616,990, on October 24, 1914. Redemption of this currency began as early as October 1914. By December 26 redemption amounted to $217 million and on July 1, 1915, all but $200,000 of the authorized currency had been retired.

The crisis of 1914 was unique in our history in that it was entirely due to external causes. The internal situation was liquid and solvent. The crisis may be said to have ended in November 1914 except for the cotton-growing southern states. Cotton was hard hit. There was a record crop of sixteen million bales, largely dependent on the European market. Cotton broke when stocks did, and the cotton exchange closed when the stock exchange closed, the closing price being 10½¢ per pound. The cotton exchange reopened in November 1914 with quotations at 7½¢ per pound, while cotton was being sold in the South for 5¢ to 6¢ a pound. An emergency loan fund was provided by banks in the northern states of $100 million, while southern banks provided $35 million. As it turned out, very little use had to be made of this fund. Less than a quarter of a million dollars was applied for in New York City, and one great bank took all of this. There came a sharp increase in foreign demand for cotton early in January 1915.

Gold and Foreign Exchange Problem. Perhaps the most acute problem that New York had to face with the outbreak of the war was the problem of gold and foreign exchange. There had been a drain on New York’s gold for a considerable time in connection with the German, French, and Russian accumulations of gold in anticipation of war. Moreover, from March 1914 to August 1914 imports of goods to the United States had exceeded exports in unprecedented amount. Europe was depressed and had reduced its buying. Our imports were not unusually large, but our exports were unusually small. Usually our heaviest imports would come in the spring,

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and our heaviest exports to pay for them, agricultural commodities, would come in the autumn. It had been a long-standing practice of American bankers to tide over the period of low exports by drawing finance time bills on London in payment for imports, which they would later liquidate by documentary bills drawn on London, connected with our heavy autumn exports. Finance bills are pure credit instruments drawn by banks on banks; documentary bills represent the actual movement of goods and are accompanied by the usual shipping documents. There had been an unusually heavy volume of such finance bills drawn in the late spring and early summer of 1914, which London was entitled to collect from New York. An additional heavy volume of payments due to London grew out of the selling of securities in New York by frightened Europeans at the outbreak of the war.

A further unusual factor which complicated the situation was the fact that the government of New York City, seeking to escape the discipline which New York bankers had sought to impose in connection with the city’s borrowing and their demand that expenditures be curtailed or revenues be increased, had borrowed $80 million on short term in England and France. With sterling exchange almost unobtainable the city’s obligations abroad were in danger of dishonor. The New York banks came to the rescue of the city and undertook to provide the necessary sterling, but administered a spanking to the city officials which the latter accepted with due meekness.

Gold Pool—England Accepts Gold in Ottawa. A gold pool of $100 million was organized by the banks of New York and other principal cities under the guidance of the Federal Reserve Board, and arrangements were made with the Bank of England whereby shipments of gold to a depository at Ottawa would be accepted in lieu of gold shipped across the ocean, thus obviating the dangers of capture by hostile warships. Sterling exchange promptly came down to a reasonable figure.

Exports Turned Tide of Gold Toward New York by December 1914. But the exchange situation would have been quickly straightened out in any case by the great increase of foreign demand for American products for war purposes. In October the United States lost $44 million in gold and in November, $7 million, but in December the tide turned and the United States gained $4 million net excess of imports over exports of gold. The explanation is the very heavy shipment of commodities on European account. From December 1914 to May 1917 (we entered the war in the middle of April), the United Stated gained gold at a rate never dreamed of before. In 1915 the excess of imports over exports of gold was over $420 million, in 1916 over $520 million, and in the first four months of 1917, over $180 million—a net gain of $1,111,000,000 in gold. The problem of exchange ceased to be how to protect the dollar, but rather, how to protect the pound and other foreign exchanges. The war crisis in the United States was over by November 1914 and in early 1915 the war prosperity began.