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2	Breakdown of World Balance, 1921–33

Nearly 80 per cent of bond flotations in the United States, and 60 per cent in Britain, during 1921–25, were by government entities: $3.6 billion in New York, nearly $2 billion in London (Table 2.1). These sums reflect the magnitude of the postwar shift from private to governmental borrowings. Although these bond issues were vast for the period, they were insufficient to enable the European Allies to pay their war debts to the U.S. Government, as repayment out of German reparations was not guaranteed.

Foreign government borrowings in London of almost $2 billion (at a parity of $5 to the pound) were a mere 7 per cent of the Inter-Ally war debts, and little more than 2 per cent of the total Inter-Ally war debts plus German reparations obligations. Yet they overwhelmed private sector issues of $1.1 billion on London during 1921–25.

These years of postwar recovery were of comparative prosperity for most of Europe. Yet the burden of Inter-Ally debt imposed by the United States compelled the governments of Europe, Allies of the United States in World War I, to impoverish their national treasuries, to run deeper and deeper into debt, to deprive their industries of needed credits, to limit their export potentials and to leave a clear field for the United States to grow as a world power to any extent and in any direction its government desired. These were the years when the United States was given – and earned – the name Uncle Shylock. The policy of compelling the European Allies – ultimately Britain – to continue after the war to meet capital and interest charges on war debts to the United States was a political aggression of first magnitude, in violation of the implied promises made during the war by the United States to its allies.

Keynes proved correct in his judgment that German society would buckle in its attempt to meet its reparations schedule. Germany succumbed to hyperinflation during 1921–22. To prevent this type of breakdown, an international economic conference had been convened in Brussels in 1920, and another was held in Genoa in 1922. In spirit, these two conferences were precursors of the 1945 Bretton Woods meetings, for they proposed many of the aims and principles endorsed after World War II by the International Monetary Fund and the World Bank. They were followed by the Dawes Plan in 1924 and the Young Plan in 1929 to coordinate the payment of intergovernmental debts by Germany to the Allied Powers. But they could not paper over the fundamentally untenable situation. Under the burden of reparations, Germany’s economy was bankrupted by the greatest inflation in history. The German middle class was wiped out, sowing the seeds for fascism.

Table 2.1 New Capital Issues in London and New York, 1921–30

(a) New Bond Flotations in the United States, 1921–30

(b) New Capital Applications in London, 1921–25

Source: Council on Foreign Relations, The United States in World Affairs: 1932 (New York: 1933), p. 74 for the U.S. figures; and William Adams Brown, The Gold Standard Reinterpreted: 1914–1934 (New York: 1940), Vol. I, p. 328 for the London figures.

Shortly after Andrew Bonar Law became Conservative Prime Minister of Britain in January 1923, he sent Stanley Baldwin and Montagu Norman to Washington to negotiate the funding of Britain’s war debt with US Treasury Secretary Andrew Mellon. Former Liberal Prime Minister Lloyd George, just displaced by Bonar Law, described the business transaction between Mellon and Baldwin as being

in the nature of a negotiation between a weasel and its quarry. The result was a bargain which has brought international debt collection into disrepute . . . The Treasury officials were not exactly bluffing, but they put forward their full demand as a start in the conversations, and to their surprise Dir. Baldwin said he thought the terms were fair, and accepted them. If all business was as easy as that there would be no joy in its pursuit. But this crude job, jocularly called a “settlement,” was to have a disastrous effect upon the whole further course of negotiations on international war-debts. The United States could not easily let off other countries with more favourable terms than she had exacted from us, and as a consequence the settlement of their American debts by our European allies hung fire for years, provoking continual friction and bitterness. Equally the exorbitant figure we had promised to pay raised by so much the amounts which under the policy of the Balfour Note we were compelled to demand from our own debtors.¹

As matters worked out, “the United States agreed to fund the debts to her of our Continental Allies on terms markedly more favourable than she had granted to Britain.” The sums funded over time stood as shown in the table.

Country-Funded Debt ($)	Total Paymentsin 62 Years ($)	Rate ofInterest (%)
Britain	4,600,000,000	11,105,965,000	3.3
Belgium	417,780,000	727,830,500	1.8
France	4,025,000,000	6, 847, 674, 104	1.6
Yugoslavia	62,850,000	95,177,635	1.0
Italy	2,042,000,000	2,407,677,500	0.4

The total sum due from Britain, including interest, amounted to over twice its original debt, having been settled at nearly twice the interest rate agreed to by Belgium, France, Yugoslavia and Italy (although identical to the 3.3 per cent charged to Poland, Czechoslovakia, Romania, Estonia, Finland, Lithuania, Latvia and Hungary). This was the price paid for being the first country to break European ranks and sign its “separate peace” with the U.S. Government – all in the name of preserving the sanctity of debt, as if Britain and its fellow Europeans were still world creditors. Here was certainly a case of economic ideology failing to keep pace with the evolution of national self-interest. “Probably,” the Council on Foreign Relations remarked, “the pact had more significance as a determinant of war debt policy than any other factor. It bound the other debtors by example to the principle of war debt acquittance; it put the American policy in a groove of formalism; it set the pace of treatment of other debtors by allowing of no other deviation than ‘capacity to pay.’” Even so, “opposition developed in the Senate against any ratification of the agreement. Not that it was felt to be too onerous; it was felt to be too lenient.”²

Mellon was clearly overjoyed. In the Combined Annual Reports of the World War Foreign Debt Commission he concluded: “We have, I believe, made for the United States the most favorable settlements that could be obtained short of force . . . The only other alternative which they [i.e., critics of the settlements] might urge is that the United States go to war to collect.” Another observer, Newton Baker, called the American principle of debt collection “the amount thought possible of collection without causing revolutions in the paying countries.”³

Perhaps the worst psychological consequence of the war debts, observed the Council on Foreign Relations, was to keep alive the question “Who won the war?” with its implicitly self-righteous answer. “It would seem that general bankruptcy should have attended the long-deferred day of reckoning for some of the Allied states. This was the outcome predicted by many observers who in prewar days had freely proclaimed the economic impossibility of waging a world war such as overtook mankind in 1914.”⁴

But unlike the situation with private debtors, there was to be no bankruptcy among national states. The U.S. Government refused to relax its unsustainable demands upon its European Allies. A 1929 observer remarked: “An American banker whom I saw today held the extreme view that ultimately Europe would declare war on the United States to repudiate her debts.” A contemporary asked: “[can] we be perfectly certain that Germany will go on cooperating, helping and pursuing a policy of peace and reconciliation, and turning her back on the policy of militarism and reaction?” He believed that a victory for Germany’s right wing was imminent as pressure built up to stop its reparations payments. “It will not mean a return to immediate armament by Germany, it will not mean an immediate outbreak of war; but it will mean the reversal of the present German policy of constructive cooperation in the building up of world peace.”⁵

The burdens imposed by international governmental finance thus prepared the ground for future war, as Lenin had anticipated that private capital and its growing concentration must do. In fact, to many observers, the hope for peace seemed to lie precisely in a restoration of international claims and investments to private hands. “At the end of 1927,” wrote the Council on Foreign Relations,

it was the hope in Europe that the United States would join in a scheme of readjustment of both debts and reparations by transplanting from the political bed of intergovernmental relationships to a wider field where they would be absorbed by private investors in the world markets of international finance. The idea was gaining ground in the United States, but the approach of responsible opinion, while recognizing the advisability of taking debts and reparations but of international politics, was lukewarm to European suggestions of a conference. It was felt that such a conference would seek to disturb settlements that are considered inviolable.

Perhaps, the Council speculated, Germany might deliver negotiable securities to the Allies, who would then market them for cash and ask the U.S. Treasury to make a once-and-for-all cash settlement for the proceeds. Intergovernmental claims thus would be limited to the private sector’s ability to finance and transfer them. Garrard Winston suggested at a University of Chicago Round Table Conference that “War debtors could very well approach the United States Treasury and suggest canceling future installments of the debt settlements by discount for cash. At reasonable current interest rates the discount would reduce payments for the later years of the term to quite attainable figures, and the menace of a continuing burden on generations not yet born would end.”⁶ Furthermore, American investors would probably be the major purchasers of the Allied bond issues, just as Germans subscribed to a great indemnity following the Franco-Prussian fear in 1871–72 and Englishmen did the same in 1816–17. To be sure, this would displace private corporate borrowing for productive purposes, but it seemed unlikely in any event that business expansion could persist without resolving the problem of intergovernmental debt service.

In short, whereas the hope for world peace prior to World War I, as voiced by Kautsky and others, lay in the prospects for intergovernmental cooperation, this now seemed dashed. Lenin had rejected Kautsky’s prescription, which he called ultra-imperialism, on the ground that it was an unattainable ideal: cartels, and the governments they influenced, could not cooperate because of the constantly shifting relative power among firms and nations, even at the monopoly level. Governments would tend to break any agreement as their actual economic strength outgrew the constraints of past international agreements.

However, what was now occurring was the concentration of world power in American hands, despite the desire by other governments to shift this power from the United States towards a more balanced and multi-centric world. World balance was prevented largely by U.S. intransigence regarding the Inter-Ally debts and its insistence that this problem had nothing to do with that of reparations. Foreign governments acquiesced, at least for the time being.

Whatever the new system was, it was no longer dominated by private sector finance capital, unless one insists on viewing the breakdown of world finance created by the Inter-Ally debts, the stock market crash of 1929 and the Great Depression as policies supported by finance capital. To be sure, the disenfranchisement of private capital was in large part the result of a war whose motivations stemmed largely from competition of international finance capital. However, the consequence of this war was to disenfranchise it, to supplant it by a system overburdened by intergovernmental claims and debts. Individualist laissez-faire in the international monetary sphere was shortsighted in advocating that their governments carve up the world and its markets even at the risk of war. The results were not what any prewar observers had anticipated, including those in the socialist camp.

The destructive effect of the postwar intergovernmental debt system was aggravated by the fact that its financial claims had no counterpart in productive capital resources, and hence no real means by which it might be paid. It was, instead, a claim for payment of the cost of destroying Europe’s resources. Keynes was quick to dispute the false analogy between the sanctity of private productive investments and the more tenuous postwar intergovernmental claims, and to deride the typical bankers’ view “that a comparable system between Governments, on a far vaster and definitely oppressive scale, represented by no real assets, and less closely associated with the property system, is natural and reasonable and in conformity with human nature.” An old country could develop a young country by private investment to bring productive resources into being, so that “the arrangement may be mutually advantageous, and out of abundant profits the lender may hope to be repaid. But the position cannot be reversed.” A young country such as the United States could not expect the older countries of Europe to be capable of out-producing her to the extent of generating a saleable export surplus sufficient to amortize the heavy Inter-Ally debts and at the same time meet internal needs. “If European bonds are issued in America on the analogy of the American bonds issued in Europe during the nineteenth century, the analogy will be a false one; because, taken in the aggregate, there is no natural increase, no real sinking fund, out of which they can be repaid. The interest will be furnished out of new loans, so long as these are obtainable, and the financial structure will mount always higher, until it is not worth while to maintain any longer the illusion that it has foundations. The unwillingness of American investors to buy European bonds is based on common sense.”⁷

Europe could directly raise the funds necessary to amortize its Inter-Ally debts by generating a payments surplus with the United States in two ways: by expanding imports into this country – that is, by making incursions into U.S. markets – and by borrowing from U.S. investors. As Frank Taussig emphasized: “Certain lines of American industry will experience additional competition from their European rivals. Consequences of this sort, even though less in quantitative importance than is commonly supposed, must be faced as a probable result of the debt payments.”⁸ Commerce Department theoreticians suggested that the United States would have to evolve into a trade deficit nation in order to finance its receipt of debt service from Europe: “If the European Governments that have not yet started to pay their debts to the United States Government should do so, there can be little doubt that imports of merchandise would regularly equal or exceed exports, as is usually the case with creditor countries.”⁹

These theoreticians accepted as axiomatic that debt repayments to the U.S. Government must take precedence over other concerns, including some shift in trading patterns between the United States and other countries. The primacy in finance of government over private interests was made nakedly obvious. Yet private U.S. interests could not go unconsidered. The dilemma of the United States lay in the contradiction between the role of world usurer played by the U.S. Government as an autonomous economic institution and the injury this must inflict upon domestic industrial interests – and hence, upon the nation – if European imports into the United States were to grow large enough to permit payment of the war debts.

The government attempted to resolve this contradiction by insisting that this was the problem of Europe, not of the United States. Europe must not be made more able to compete in U.S. markets. By inference, therefore, Europe must meet its debt obligations not by expansion of overseas commerce, but by reduction of consumption. The obvious means to this end was to limit European imports into the United States by raising tariffs. Europe, then, must limit consumption in order to raise a surplus out of which to meet its debts. To monetize this surplus, Europe must sell abroad what it saved out of reduced consumption – but not in U.S. markets.

The government of the United States after World War I thus established the precedent that, through government international finance capital, the United States would influence the direction of growth in world commerce and, simultaneously, the consumption functions of other nations. U.S. tariffs served the double purpose of sheltering domestic industries and influencing the direction of world trade, each within the context of the paramount needs of intergovernmental debt service. Minimizing consumption in Europe increased both the margin out of which debt payments could be made and the creditworthiness of Europe, so that Europe could borrow in U.S. capital markets, further facilitating principal and interest payments on the intergovernmental debt.

However, the United States refused to permit Europe to pay off its World War I debt by exporting more goods to the United States. The country’s tariffs were raised in 1921 specifically to defend U.S. producers against the prospect of Germany and other countries depreciating their currencies under pressure of their foreign debts.¹⁰ In May of that year prices began their collapse in the United States, following the drying up of European markets that had been supported by U.S. War and Victory loans. An emergency tariff on agricultural imports was levied, followed in 1922 by the Fordney Tariff which restored the high level of import duties set by the Payne-Aldrich Act of 1909. Tariffs on dutiable imports were raised to an average 38 per cent, compared to 16 per cent in 1920.

Even more devastating to international trade, the American Selling Price features of the 1909 Act were also restored as the “equalized cost of production” principle and applied to a number of commodity categories. This meant that tariffs were levied not according to the value of imports as charged by foreign suppliers, but according to the value of similar goods produced in the United States. This legislation made it virtually impossible for other economies to undersell American producers in their home market. The President was authorized to raise tariffs wherever existing duties were insufficient to neutralize the comparative advantage of production costs enjoyed by other countries.

The economic principle of international comparative advantage thus was denied in law. Neither Germany nor the Allies could obtain the dollars necessary to pay their intergovernmental debt by running a trade surplus with the United States and displacing American labor. Their alternative was to raise the funds by new private sector borrowings in the United States.

Labor spokesmen endorsed this policy of European borrowing in the U.S. private sector instead of selling more products to the United States. Matthew Wohl, vice-president of the American Federation of Labor, recognized that the U.S. Government was only “going through the motions of collecting these debts. Europe is going to pay with one hand and borrow back with the other, and go on using the capital just the same . . . it is better for us that it shall be so, instead of actually receiving payment in goods that would interrupt our own industries. I think it is a safe guess that fifty years from now the United States will have more loans and investments abroad than it has today, including these debts, and this will mean that we will not have received actual payment of these debts. They will only have changed their forms.”¹¹

The transformation of intergovernmental debts to private debts took the form of a triangular flow of payments. Funds flowed from the United States to Germany, from Germany back to the European Allies, and from these back to the United States. During 1924–31, U.S. private investors lent $1.2 billion to German municipalities and industries, and other countries lent an additional $1.1 billion.¹² The Reichsbank used these dollars to pay reparations to the Allied Powers. Some went directly to Britain, others to France to be used by France to pay Britain on its wartime loans. Britain and the other European Allies then paid the funds to the U.S. Government to service their war debt. Intergovernmental claims thus became partially supplanted by and integrated with private investment capital. Europe’s debt repayments tended to inflate the American credit base, making accessible to U.S. investors still more funds to lend to Germany and other European countries.

This circular flow of payments was maintained precariously, but with no realistic hope of its functioning perpetually. The assets required to underwrite the debt simply did not exist. As Keynes wryly described the situation: “the European Allies, having stripped Germany of her last vestige of working capital, in opposition to the arguments and appeals of the American financial representatives at Paris . . . then turn to the United States for funds to rehabilitate the victim in sufficient measure to allow the spoliation to recommence in a year or two.”¹³ For Germany and the Allies, wrote another economist, the “only incentive to agree to pay is the opportunity to get new private loans not otherwise obtainable.” The U.S. stake “from the beginning was represented by the sum we could persuade our debtors to pay us, while not permitting our demands to rise so high as to prevent settlement and delay the restoration of international trade and commerce. We had nicely to appraise the relative values of old debts and new business.”¹⁴

During 1928–29 the circular flow of payments between the United States and Europe began to break down, first by a slowing down in U.S. private purchases of foreign bonds when investments increased domestically in response to the stock market boom; then by the market collapse which erased lendable assets; and finally by the Great Depression, itself the product of the impossibility of pyramiding debt to infinity. The first great swelling of intergovernmental claims came to an end in bankruptcy on a world scale.

First came the problems associated with sterling, toward whose stability the British Government sacrificed the nation’s living standards in a deflationary process in 1926. On the one hand, a higher value for sterling meant that a given number of British pounds would exchange for a greater number of dollars and thus pay off a larger value of dollar-denominated debt. On the other, this worked to price British exports out of world markets, reducing Britain’s ability to earn dollars and other foreign exchange. Internal deflation thus was accompanied by loss of export markets, high interest rates which deterred investment, and a wave of strikes culminating in the General Strike of 1926.

Meanwhile, the attempt by the U.S. Government to help foreign governments maintain their Inter-Ally debt service set in motion responses that prevented this process from continuing. After 1926 the Federal Reserve System helped Britain hold the pound sterling at its (overvalued) prewar level by promoting low interest rates in the United States via a policy of monetary ease. As long as British interest rates exceeded those of the United States, Britain was able to borrow the funds needed to sustain its Inter-Ally debt transfer. Thus “American support for the pound sterling in 1927 implied low rates of interest in New York in order to avert big movements of capital from London to New York . . . but presently America herself was in need of high rates as her own price system began to be perilously inflated (this fact was obscured by the existence of a stable price level, maintained in spite of tremendously diminished costs).”¹⁵

The United States could not raise its interest rates without depriving Britain of the ability to borrow the money (mainly from U.S. lenders) to pay its war debt. “As long as America lends freely to the world, and thus gives the nations greater buying power than otherwise they would have,” George Paish wrote in 1927, “Great Britain will be able to continue to buy from America and to sell to other nations. But should anything occur to cause American investors and bankers to stop their loans to foreign countries, Great Britain’s position would become most precarious. . . . If a time should come when [Britain’s] credit is exhausted and she is forced to reduce her purchases to the limit of her selling power, less her reparation and interest payments, then the full consequences of the impoverishment of the German people will be experienced by other nations.”¹⁶ The U.S. financial sector thus became responsible not only for its own prosperity, but also for that of its debtors including, indirectly, Germany. The government could collect on its Inter-Ally debts only so long as its own investment bankers and other investors would provide the funds. To be sure, the longer this process continued, the longer it seemed that it could go on forever. Economists even began to speak of a new era of world prosperity rather than examine the shaky foundations on which the world’s growing debt pyramid rested.

U.S. interest rates were held down in part by the inflationary money creation facilitated by the Treasury’s receipt of foreign debt payments. As is normal in such situations, the credit inflation made its first appearance in the money and capital markets: the price of stocks and bonds was bid up considerably before commodity prices began to rise. By 1928 nearly 30 per cent of bank assets were devoted to broker loans to finance stock market speculation (requiring only 20 per cent down payment, with favored customers putting up as little as 10 per cent of the price of their stocks). “As rates on call loans ran above other market rates by wide margins, funds were drawn into the New York stock market from all over the country and from financial centers abroad,” much of it in the form of short-term funds. This became a major factor curtailing new American loans to Europe – and to Germany in particular – loans without which U.S. export trade could not be financed. And without exports there could be no American prosperity, at least not without a sharp economic readjustment. Stocks and bonds soared even as earning power was threatened by the situation developing. “An extraordinary volume of new issues of common stock was floated toward the end of the boom – $2.1 billion in 1928 and $5.l billion in 1929, as compared with a total of $3.3 billion in 1921–27 and the later postwar peak of $4.5 billion ($2.65 billion ‘net change’) in 1961.”¹⁷

America’s speculative prosperity undercut world equilibrium as “investors turned from foreign bonds to American stocks since that was where the greatest gains were to be made. The rise in stocks brought European funds into the American market. The cessation of lending drew gold to balance the accounts. The combined effect was to force a contraction of credit in the outer world which undermined gold prices. A year later international prices fell so rapidly that they impaired the position of the debtors. This in turn forced a further contraction of credit and set prices and credits spinning in a vicious spiral of deflation. The depression which had begun in the far corners of the world in 1928 reached the United States and Europe in 1929–30.”¹⁸

Private funds flowed increasingly from foreign stock markets to the U.S. market. This explains why Europe’s stock markets peaked before the U.S. market. “Abroad, stock markets had peaked in Berlin in the spring of 1927, in London and Brussels in April and May 1928, in Tokyo in midsummer 1928, in Switzerland in September 1928, and in Paris an Amsterdam early in 1929.” Not until September 1929 did the U.S. stock market turn down; and following Black Friday, on October 24, the New York market collapse accelerated further declines abroad. The London Economist reported in December that “Wall Street speculation ceased to be a national and became an international problem, and one that affected London, the world’s financial center, most of all.”¹⁹

In point of fact the U.S. economy and its financial markets were most seriously affected by the stock market crash and its aftermath. Despite the fact that the U.S. economy was much less exposed to the vicissitudes of international financial and trade movements than other countries relative to the size of its national income and wealth, its financial practices were much more highly pyramided. Checking accounts were used more in the United States than abroad. Furthermore, the years of monetary ease in the United States had spurred a tripling of consumer debt and security loans, mortgage debt and nearly all forms of credit during 1921–29. This pyramiding was now called in by the banks – at a time when most home and farm mortgages came up for renewal every three years – contributing to a wave of foreclosures in the wake of stock market margin calls.

The United States thus became a major victim of its own intransigence with regard to the Inter-Ally debt problem. Its national income fell by $20 billion in 1931 (from a $90 billion level in 1929), losing “in a single year three times as much as the whole capital value of the war-debts due to her, and nearly eighty times as much as the total of one year’s annuities.”²⁰ Its exports and domestic tax revenues fell correspondingly. The illusion that Europe could settle its war debts and reparations on a workable basis by borrowing the funds from U.S. investors ad infinitum was shattered. “What had actually happened was that they were supported by an increasingly dizzy structure of private debt. It was a structure which could stand only so long as it was raised higher and higher. By June of 1931 the whole structure was in collapse, threatening to bring down with it in one smash all the public and private debts of Germany.”²¹

President Hoover declares a moratorium on Inter-Ally debts

On June 5, 1931, Germany appealed to the world to forgo demand for reparations payments. Andrew Mellon, still Secretary of the Treasury, met with President Hoover on June 18 and convinced him that Germany could not possibly meet its scheduled payment. A number of leading financial houses and banks in New York were heavily involved in the German bond market and “were threatened with bankruptcy in the event of a wholesale default by Germany.”²² The President held a series of Cabinet meetings and met with Republican and Democratic congressional leaders to obtain general endorsement of a one-year postponement of all payments on intergovernmental debts.

This became his moratorium plan of June 20, which froze all private as well as governmental short-term German liabilities. He emphasized, however, that he did not approve “in any remote sense, the cancellation of debts to the United States of America.” True, he acknowledged, the basis of debt settlement was finally to become “the capacity, under normal conditions, of the debtor to pay . . . I am sure that the American people have no desire to attempt to extract any ounce beyond the capacity to pay . . .” But every ounce up to that point would be expected. Yet to Europe the term “capacity” meant capacity to pay put of reparations receipts; to America it meant the capacity to pay out of ordinary budgets, assisted preferably by cuts in arms expenditures.²³

Nonetheless, Hoover’s announcements made stock markets jump throughout the world, and improvements in foreign exchange conditions more than repaid the United States for the loss of the nominal $250 million sum of funds forgone.²⁴ The winding down of intergovernmental claims thus had a salutary initial effect on the network of private international finance capital.

However, letting Germany off the hook shifted the focus of world anxiety to London. Publication of the Macmillan Report in July 1931 disclosed that Britain’s foreign short-term credits amounted to over £400 million as against her realizable short-term foreign claims of only about £50 million after deducting the uncollectible Central European claims. On July 13, the day the Macmillan Report was made public, the Danat Bank closed its doors. A run on sterling dislodged its exchange parity, and Europan exchange rates began to collapse under the accumulated debt burdens of the preceding decade.²⁵ The Hoover Moratorium had come too late.

As in a Greek tragedy, inexorable forces were set in motion. To begin with, Britain’s devaluation impaired Germany’s export potential. British coal, for instance, became cheaper than German coal, so that German ships took on British coal at Rotterdam rather than buying domestic coal in Bremen and Hamburg. To make matters worse, many German firms had carried on their business in sterling, and suffered considerable loss when its exchange rate fell.²⁶

These events triggered a worldwide tariff and devaluation war. Britain’s abandonment of the gold exchange standard was followed by similar moves by the Scandinavian countries (Sweden, Denmark Norway and Finland) and by Portugal, Greece, Egypt, Japan, several South American states with major trading ties to Britain, and by the British Commonwealth generally. These nations formed a de facto Sterling Area capable, in principle of, turning the tables of international economic power against the gold standard countries, led by the United States and France, which between themselves were left with 80 per cent of the world’s monetary gold. But what good was this bullion if an alternative instrument, paper sterling, were to become acceptable by most of the world in preference to continued subservience to gold? This potential contributed to Anglo-French and Anglo-American economic tensions, And fear of a new world trading system based on devalued sterling underlay much of President Roosevelt’s subsequent hard line towards Britain.

How could this deterioration of the world economy have been avoided? The German Government scarcely could have worked harder to meet its reparations obligations. Throughout the 1920s there was little talk of suspending these payments, and Germany’s political parties vied to devise ways in which the payments schedule might be met.²⁷ The European Allies also tried their best to service their debts to the United States. This is not to say that they were blameless in their relations with Germany. The Poincaré Government in France was especially vindictive and, after occupying the Ruhr in 1923, replied in the following words to Britain’s protest over this act:

An eye for an eye, a tooth for a tooth. In strict accordance with the precedent established by Germany in 1871, the Ruhr District will be released only when Germany pays. The Reich must be brought to such a state of distress that it will prefer the execution of the Treaty of Versailles to the conditions created by the occupation. German resistance must cease unconditionally, without any compensation. Germany’s capacity to pay cannot be established at all in presence of the present confusion in her economy. Furthermore it is absurd to fix it definitely, as it is continually changing. The German Government will never recognize any amount as just and reasonable, and, if it does, it will deny it on the f following day. In 1871 nobody in the world cared whether France considered the Treaty of Frankfort just and possible of execution. And what about the investigation of Germany’s capacity to pay by impartial experts? What does impartial mean? Who has to select the experts?²⁸

The Allies were extortionate in their ways of exacting tribute from Germany, but they were acting under the force majeure imposed by the United States’ insistence that their war debts be paid to the last cent, including interest. Because the U.S. Government was the ultimate claimant on all war debts, the failure to achieve a realistic solution to the transfer problem cannot but be attributed to U.S. policy.

With regard to world indebtedness, the United States had adopted a double standard. Under the Dawes Plan, Germany was protected against enlargement of the real burden of her reparations payments by a fall in world commodity prices relative to the dollar, or more properly, relative to gold. The Dawes Plan stipulated that “the German government and the Reparation Commission each have the right in any future year, in case of a claim that the general purchasing power of gold as compared with 1928 had altered by not less than 10 per cent, to ask for a revision on the sole and single ground of such altered gold value,” and that “after revision, the altered basis should stand for each succeeding year until a claim be made by either party that there has again been a change, since the year to which the alteration applied, of not less than 10 per cent.”²⁹

This provision recognized that the sum of reparations payments by Germany, as fixed under the Dawes Plan, was the maximum the Allies could extort. In fact, it was beyond the capacity of Germany to pay, as any increase in the real value of the reparations debt must impoverish Germany to the point of national exhaustion. Hence, the protection extended to Germany against the terms of trade turning against her as between the changing values of commodity exports and fixed gold-mark reparations payments.

Similar treatment was not accorded to the Allies with respect to their debts to the United States. America refused even to contemplate that given a fall in world prices – a rise in the value of gold as measured in commodities – the Inter-Ally debts, which amounted in practice to Britain’s and France’s debts to the United States, no more could be paid by Britain than reparations could be paid by Germany. U.S. policy was to treat Germany, the recent enemy, as a country in need of protection against the effects of a fall in prices, but to treat Britain, the recent ally, as a nation to be trodden down if a fall in world prices should occur. The recent enemy was to become a ward of the U.S. Government; the recent ally to be punished.

Because this ally was the world’s great imperial power and Germany its recent challenger for imperial supremacy, the suspicion is warranted that the United States had set its eyes lustfully on the British Empire. To swallow the Empire, the United States must first dislodge it. Britain must be forbidden the fruits of victory and Germany established again as its rival. The same policy was to recur after World War II.

World debt had become, and was used as, an instrument of power by the United States against its only serious rival, the British Empire. Britain was held responsible for payment to the United States of Germany’s reparations equivalents to Belgium, France and Britain, whether or not Germany could and did make such payment. The British debt was to be increased in real value if commodity prices should fall, but Germany’s debt obligations to Britain, both direct and indirect, were to be substantially protected in terms of its commodity price equivalent.

The derailing of international debt service prompts controversy

For a decade the world’s debt overhang had been kept afloat by the expedient of yet more debt. Private U.S. lending provided dollars that followed a triangular route to German municipal and private borrowers, via the German central bank to the governments of Britain, France and other Allied Powers, who recycled the dollars back to the United States. But the Great Crash of 1929 extinguished vast pools of paper capital, drying up sources of international borrowings. In 1931 international short-term debt was reduced between 33 and 40 per cent, withdrawing about $6 billion from commercial use in the debtor countries.³⁰ The reduction of credit would have been much greater had it not been for the standstill agreements that froze short-term loans to Germany. The effect in any case was violently deflationary, collapsing world prices and trade. Foreign governments were unable to raise the dollars needed to pay their scheduled debt service, either by increasing their exports or by borrowing new private funds.

Almost unable to borrow abroad, Germany reduced its reparations payments. In 1932 it cut back its debt-service transfer first by half, then by 70 per cent. Meanwhile, Britain’s attempt to continue paying its share of the Inter-Ally debts, despite the slowing reparations receipts from Germany, forcing down the value of sterling at the same time that British prices were tumbling.

The decline in world prices increased the real burden of debt service because the transfer requirements, measured in commodities, increased as the dollar price of these commodities fell. “Since the various installments of that debt were negotiated and spent in this country, our price level has fallen by perhaps 50 per cent, thereby approximately doubling the actual payments demanded.”³¹ Yet the U.S. Congress was adamant that the Hoover Moratorium was merely a one-year postponement, not a cancellation of foreign indebtedness to the U.S. Treasury and certainly not contingent on Europe’s success in extracting further reparations from Germany. On December 10, 1931, President Hoover reassured Congress that “Reparations are a wholly European problem with which we have no relations.” And when the Brookings Institution published Harold Moulton’s analysis of the French war debt problem, leading the Foreign Debt Commission to scale down the U.S. claims on France, Hoover told a press conference that Moulton “represented a liability to the United States to the extent of $10 million a year in perpetuity.”³² He subsequently asked Congress to reestablish the Foreign Debt Commission with a possible eye to scaling down the debts, but his request was in vain, despite support by Senator Borah, Chairman of the Committee on Foreign Relations.

The representative U.S. view was epitomized in ex-President Calvin Coolidge’s terse comment, “We hired them the money, didn’t we?”³³ On December 17 the House Ways and Means Committee reported that “It is hereby expressly declared to be against the policy of Congress that any indebtedness by foreign countries to the United States should be in any manner canceled or reduced.” A minority report went so far as to criticize President Hoover for proposing the reparations-and-debt moratorium in the first place, without first having consulted the full Congress. But on December 22, 1931, the Hoover Moratorium finally was ratified, although Congress charged the nation’s debtors 4 per cent on their outstanding balances, on the ground that this was the rate at which U.S. Treasury bonds were then selling. This somewhat awkwardly obliged the Allies to renegotiate their waiver of German reparations under the Hoover plan, increasing the rate of interest charged on Germany’s postponed payments and on their mutual indebtedness from 3 per cent to 4 per cent.

Meanwhile, Britain was forced to abandon the gold exchange standard in September 1931. Its attempt to service its debt to the United States had resulted first in a deflation of its domestic prices stemming largely from the government’s budgetary needs to raise the sterling equivalent of its debts to the U.S. Government; and then, despite this deflation, a collapse of its currency against those of other nations as it converted sterling into dollars. This transfer aspect of the debt problem disturbed Europe’s economies even more than their domestic budgetary problems.

The Lausanne Conference proposes to settle the debt tangle

At the Lausanne Conference in summer 1932, six months after the Hoover Moratorium, it was clear that the Allied Powers could not extract any more funds from Germany, and they turned to save themselves from their own debts to the United States. When Germany proposed a lump-sum final settlement of its reparations, Premier Herriot of France pointed out that “cancellation of reparations without a corresponding readjustment of allied war debts would place Germany in a privileged position.”³⁴ Italy’s foreign minister proposed on July 4 that war debts and reparations be wiped off the books altogether. At the end of the conference the European Allies agreed to waive German reparations to the extent that the U.S. Government would waive its war claims against them. Herriot announced in an interview with the newspaper L’Intransigeant: “What must be clearly understood is that the link is now clearly established between the settlement of reparations and the solution of the debt problems with relation to the United States. Everything is now subordinated to an agreement with America.”³⁵

The European Allies reasoned that they hardly could afford to give up German reparations if the price would be a stripping of their own gold stocks to continue paying for a war whose economic aftermath they now wanted to end. They agreed to cut German reparations by nearly 98 per cent, from $30 billion to about $700 million under a gentlemen’s agreement that the write-off was conditional on the United States’ reducing its own claims on the Allies. With a motto sanctified by the Lord’s Prayer, “Forgive us our debts, as we forgive our debtors,” Britain and France signed an addendum to their agreement with Germany stipulating that “if a satisfactory settlement about their own debts is reached, the aforesaid creditor Governments will ratify and the agreement with Germany will come into full effect. But if no such settlement can be obtained, the agreement with Germany will not be ratified; a new situation will have arisen and the Governments interested will have to consult together as to what should be done.”³⁶

U.S. politicians accused Europe of forming a united front against the United States. (It was an election year, after all.) The Lausanne Conference disbanded in some disarray as American anxiety began to be awakened with regard to the prospect of British and French trade resurgence. U.S. officials began to worry that they had pressed their creditor position too far in forcing Britain and its Empire off the gold standard, for this freed Britain, its Commonwealth and associated Sterling Area countries to create their own commercial bloc if they so chose. Almost immediately they did exactly this at the Ottawa Conference convened by Britain to establish a generalized system of Commonwealth tariff preferences, with the potential of extending their trade and currency system to any nation choosing to adhere to the Sterling Bloc.

Even before the Ottawa Conference, American economic antagonism toward the British Empire was apparent. In the Senate debate on the Hoover Moratorium, Senator Reed of Pennsylvania dismissed as “silly” the idea that payment of war debts could present any great difficulty to a country like Great Britain, “owning far-flung colonies, holding funds all round the circle of the globe, with museums stuffed with art treasures worth millions and millions.”³⁷ The implication was that Britain should sell these art works, along with its colonies, to pay what remained of its war debt. The drive to break up the British Empire had thus begun in embryonic form. But so reluctant was Europe to recognize this ultimate policy intent – still only in its germinal stage – that the only response was an angry editorial in The Times of London denouncing the suggestion that Britain ship its National Gallery and the British Museum to New York in partial satisfaction of its debts.

The Hoover Moratorium expired on June 30. The first payment due was that of Greece on July 1. It “notified the Treasury Department that it would take advantage of a clause in its agreement with the United States permitting it to postpone payment for two and a half years, with interest to accrue on postponed amount at 4¼ per cent.” Smaller debtors followed suit.

The Hoover Administration recognized the need to negotiate some longer-term resolution, toward which a Preparatory Commission of Experts met at Geneva in autumn 1932. The U.S. representatives were John H. Williams, a respected Harvard economist specializing in balance-of-payments analysis who had worked for some years as a consultant to the New York Federal Reserve Bank, and Edmund E. Day. “One important development in the intergovernmental situation is indispensable,” their report stated: “a definitive settlement of the war debts must be clearly in prospect, if not already attained, before the Commission comes together again . . . With a satisfactory debt settlement in hand, or in the making, and with a willingness on the part of two or three of the principal powers to assume initiative in working out a program of normalization of the world’s economic order, the next meeting of the Preparatory Commission may be expected to yield highly important results.”³⁸

The report was not made public in view of the nationalistic views of most voters, but Hoover and his Cabinet saw the writing on the wall and planned to implement its recommendations. Their stance was shaped by the fact that the balance of forces dealing with the Inter-Ally debts did not involve only the European and U.S. Governments. Private bankers also had an interest in alleviating the burden. Enlightened and compassionate as their internationalist position may have been, it was not entirely altruistic, for intergovernmental debt service had thoroughly crowded out private lending. Whereas private loans had played a facilitating role prior to 1929, the Crash had destroyed capital and debt-paying power from one economy to the next, forcing a choice to be made between Europe paying either the U.S. Government or, potentially, American bankers.

The bankers favored international debt leniency on the part of governments for much the same reason they did in 2000 when they urged that governments, the World Bank and IMF forgive the official debts owed by the poorest Third World countries. Their objective was not so much to let Third World debtors off the hook as simply to remove governments from their senior status as first claimants on the export revenues and foreign exchange generated by debtor countries selling off their public domain to pay foreigners. Government forgiveness meant that all the available revenues of the poorest countries would be “freed” to be paid to large private global creditors.

Farm interests also had an interest in alleviating Europe’s debts, for the more it had to pay in debt service, the fewer dollars it could raise to buy U.S. farm output. However, notes Raymond Moley, Roosevelt’s advisor on the debt issue, “the debt payments are relatively unimportant in comparison with the interest on the private debts (foreign bonds, etc.) and payments on short-term bank paper of which eight hundred millions (about) are in New York.”³⁹ The issue of the primacy of intergovernmental or private finance capital thus was the determining issue. One or the other had to give.

The question was whether it would be intergovernmental debts or private loans that would suffer. Favoring private creditors, Hoover and his Republican Cabinet were amenable to seeing the government relinquish its claims on Europe. Roosevelt and his economic nationalists put the public sector’s interest first, that of private creditors last. To Moley and Rex Tugwell, two of the leading members of Roosevelt’s Brains Trust, that was the essence of the New Deal’s political philosophy. Tugwell pointed out that one reason why the Eastern establishment’s bankers favored cancellation or at least a major reduction of the debts was that it would help in the revival of their own international loan business. That was the essence of their internationalist position. Even though “the debtor countries were able to pay their installments, the international bankers wanted the government debts out of the way to help the revival of their own business abroad.”⁴⁰

The prospect of negotiating a settlement of European debts a was disrupted when Franklin Delano Roosevelt defeated Hoover by a heavy plurality in the presidential election held on Tuesday, November 8, 1932. The Democrats also captured the Senate and House of Representatives, giving the White House control over policy. No mention of the war debt issue had been made at the Republican National Convention held in June 1932, but the Democratic Convention formulated a plank registering opposition to their cancellation.

Allied debt payments were scheduled to begin falling due just two days after the election, starting with Greece’s November 10 payment on its nonpostponable payment of $444,920. It defaulted. This was not unexpected in view of its June request for a postponement. More unsettling that day was the fact that “the British and French ambassadors had called on the Secretary of State Henry L. Stimson to ask for a review of the entire question of debts and, pending such a review, for a postponement of the installments due on December 15th.” Their notes demanded “not only that the debt payments due on December 15 be deferred but that we review the whole debt situation with debtor nations.” Stimson described this demand as a “bombshell,” but urged Hoover to take a lenient line toward the debts, hoping to avoid the outright break with Britain and other debtors that defaults would cause. In fact, reports Moley, Stimson “was not happy about Hoover’s determination not to cancel the debts without an adequate quid pro quo or about the President’s refusal to link the debts with reparations.”⁴¹

Roosevelt, Moley and Tugwell took a much less “internationalist” position, reflected in Moley’s complaint that Stimson’s professional life “had been that of a New York lawyer in close contact with the great international financial and cultural community that centered in that city . . . he leaned heavily upon advice from New York, especially from the partners of the Morgan company.” In fact, “Stimson’s sympathies for any relationship with the New York banking community were greater than Hoover’s and [Treasury Secretary] Mills’s.”⁴² Roosevelt’s supporters, especially from the silver states, were soft-money populists sympathetic to debtor-oriented inflationists, as it was the West that owed money to the East Coast bankers.

America’s leaders thus looked first to the domestic economy, not anticipating the scope of the world’s financial problems or grasping the extent to which the nation’s hard line toward European war debts would provide new impetus urging the continent toward a renewed nationalism and autarchy that would culminate in World War II.

America’s reasoning was neither devilish nor incorrect, as far as it went. But it did not go far enough. Europe did everything it could to avoid default on the tangle of reparations and Inter-Ally debt payments in the absence of U.S. permission to stop payment. This permission was not given. America therefore left Europe virtually no alternative but to pursue creditor-oriented deflationary policies at first, and protectionist and nationalistic policies after dollar devaluation in 1933–34. Domestically, the U.S. economy adhered to a much more populist, debtor-oriented economic philosophy than did Europe, but internationally it held to a hard creditor line.