Better off in a Stocking

Shortly after​ ten o’clock on the morning of Friday, 31 July 1914, less than an hour before trading was scheduled to begin, the London Stock Exchange closed its doors to business for the first time since its establishment in 1801. Crowds of brokers gathered in the narrow streets outside the building, many already wearing straw hats and holiday clothes instead of the traditional silk hat. The crisis in Europe had worsened dramatically over the previous week – Austria-Hungary had begun its bombardment of Belgrade just two days earlier – but few had expected that fear of war would bring business in the City to a complete halt. As news spread of the markets’ sudden loss of nerve, anxious queues began to form outside the Bank of England. It was the Friday before the busiest bank holiday of the year, so a full-scale run was averted: many people had already left London. Nonetheless, this was a crisis on an unprecedented scale. By 1914 the Stock Exchange was trading a third of all securities issued anywhere in the world. Its closure made clear that the situation in Europe was far worse than many had realised. ‘We all went away for our holidays,’ the financial journalist Hartley Withers recalled, ‘to come back to a new strange world, in which many of the old lights that guided us had been put out and the red glare of war had taken their place.’ By 4 August, Britain would not only be at war with Germany, but at the centre of the first truly global financial crisis.

That crisis is almost completely forgotten today, overshadowed by the war that followed on its heels. But it was the worst ever systemic collapse of the British financial system and the first to be transmitted nearly instantaneously across the globe: to East Asia, Latin America, Africa and the Pacific. It also marked the beginning of the end of Britain’s global economic hegemony: after 1914, London was gradually overtaken by New York as financial capital of the world.

The immediate trigger for the crisis was the aggressive ultimatum Austria-Hungary issued to Serbia on the evening of 23 July, which was widely seen as a pretext for invasion. Convinced that war had become possible, Europeans raced to turn their investments into cash, and the panicked selling of securities caused prices to collapse. Between 20 and 30 July, the price of shares in major businesses fell dramatically: Canadian Pacific Railway and Rio Tinto Copper dropped 15 and 24 per cent respectively. With everyone looking to sell, and almost no one to buy, the market in securities evaporated. On Sunday, 26 July, the bourses in Vienna and Budapest decided to close, followed by Brussels and Oslo, and then the Paris Coulisse market (the unofficial stock exchange) the day after. Word of the panic was transmitted by telegraph across the world: on Tuesday, stock exchanges in Portugal and Spain were shut as fist fights broke out on the streets of Barcelona. By Wednesday, the contagion had spread to Amsterdam, Berlin, St Petersburg, Montreal and Rome, and by Thursday, to Shanghai and Cairo. By Friday, the only two major exchanges left open, New York and London, were closed too. (Smaller holdouts – Johannesburg, Sydney and Melbourne – followed suit the following Monday.) Fears of financial collapse led to bank runs in Argentina, Peru, the Dutch East Indies and Hong Kong. None of the countries that had tied their fates to the newly emergent global financial system escaped unscathed.

The City of London was at the heart of this system, having overtaken Amsterdam as the world’s chief financial centre in the early decades of the 19th century. This had been made possible by Britain’s growing commercial and industrial strength and by the reach of its empire, and London’s position grew even stronger later in the century as innovations in transport and communications, particularly telegraphy, allowed for the rapid worldwide transmission of prices and orders. As the world became smaller, London grew in importance as the hub of its commercial network; payments for much of the world’s trade were funnelled through financial institutions in the City. By the eve of the First World War, London boasted the largest market in securities, capitalised at more than £11 billion in government bonds and shares in railway, mining and infrastructure companies from around the world.

British capital moved outwards as well. Investment trusts exported domestic savings to 170 different countries and colonies. Thanks to the worldwide availability and reliability of bills drawn on London, the pound sterling came to function as the world’s de facto reserve currency, particularly after most major economies had linked their national currencies to the gold standard, allowing easy convertibility between them. While the American and German industrial bases had caught up with and even surpassed Britain’s by the early 20th century, the City remained the financial centre: ‘It may be that hides and rabbit skins are being sold from Australia to New York,’ one merchant banker wrote in 1914, ‘or coffee from Brazil to Hamburg, or eggs and butter from Siberia to London, or herrings from Aberdeen to Russia, or machinery from England to South America, or cotton goods from Lancashire to India and Australia. The buyers and sellers settle up their transaction in London.’

Almost no one had considered how to prevent this complex and delicate arrangement from falling apart under the strains of war and political instability. Few states had made contingency plans for coping with economic crises; responsibility for handling earlier panics in Britain – in 1847, for example, and 1890 – had fallen mostly to the Bank of England, an institution that guarded its independence from the state. There were no international mechanisms to prevent the transmission of crises or to co-ordinate intergovernmental responses to them. In the last week of July, it became clear just how unprepared Britain was, as the race for liquidity across Europe threw its entire financial system into turmoil.

The first people to suffer were the ‘jobbers’, the middlemen responsible for buying and selling shares on the Stock Exchange, who suddenly found themselves worth less than the sum of their liabilities. In order to finance their transactions, jobbers required significant capital up front, which they borrowed from the City’s joint stock banks, using the securities they traded as collateral. As the value of these securities dropped, the banks demanded additional collateral, forcing many jobbers into bankruptcy. And as more firms went under, and the banks watched their money disappear, the logic of closing the Stock Exchange, a course of action that had seemed scarcely imaginable, suddenly seemed obvious. Prices couldn’t continue to drop if no one was quoting them.

At the same time as trading in securities was frozen, the London money market broke down. This had even more dramatic consequences: half of world trade at that time – and almost all of British trade – was financed via one of the major instruments traded on the money market, the sterling bill of exchange. This was a transferable promissory note, usually with a three-month maturity, that offered a convenient means of settling international transactions. An American merchant buying silk in Japan, for example, could pay for his goods with a sterling bill, which the Japanese merchant would then sell to a bank in Japan in exchange for local currency. The sterling bill would next be presented to an ‘accepting house’ in London (essentially a merchant bank, like Rothschilds or Schröders) that, for a fee, would ensure payment in case of default. The bill would then be sold again on the secondary market via a discounting house, typically to a bank that would hold the bill as a means of increasing its liquid reserves. When payment on the bill was due, the American merchant would send to London the amount he owed for the silk he had bought in Japan. Since sending actual bullion was impractical, and since the money he owed was in pounds sterling, the merchant would typically purchase another sterling bill using dollars he had earned from selling the silk at home, and that bill would pay off his debt to the bank in London. In this way, sterling bills facilitated the vast expansion of international trade in the late 19th century, providing a ready means of connecting most of the globe in an integrated commercial network. One of the first important tasks in the drawing up of international law was to regulate the global use of bills of exchange at the Hague Conferences of 1910 and 1912. Some considered these bills superior to gold – ‘more economical, more readily transmissible, more efficient’, as one Canadian banker put it. The City’s secondary market in sterling bills linked the world’s banks in a common system of exchange: its investment opportunities encouraged more than seventy foreign banks to open branches in London, with as much as half of the money changing hands on Lombard Street originating from outside the country. As early as 1873, Walter Bagehot referred to the London money market as ‘by far the greatest combination of economical power and economical delicacy that the world has ever seen’.

But the highly interconnected nature of this system was what made it so precarious: at any given moment, the entire world was indebted to London on a staggering scale, with enormous sums due daily to financial institutions in the City. In late July, it suddenly became difficult for foreign borrowers to remit payments to London. Fearing that they’d be liable if payments weren’t received, merchant banks stopped accepting new sterling bills from 27 July. At the drop of a hat, the world’s premier financial instrument became unavailable. Unable to acquire new sterling bills, even solvent firms now couldn’t send money to London, particularly as war conditions made shipping gold all but impossible. This was the paradoxical disadvantage of being the world’s financial hegemon: if the City didn’t receive prompt payment from its international debtors, its banks would refuse to provide more credit, even though this was needed for foreign debtors to meet their obligations to London. This further worsened the position of London and that of its debtors, and so on. No one else was rich or powerful enough to break the vicious circle.

The dual crises in the securities and money markets left the City’s joint stock banks reeling. Their major sources of liquidity – sterling bills of exchange and loans to stock traders and discounting houses – were all but worthless. With insufficient cash to hand, they were dangerously exposed in the event of a run. They called in their loans, withdrew funds from the Bank of England and hoarded gold. Customers withdrawing deposits were handed unwieldy five pound notes instead of the standard gold sovereigns, which precipitated a brief run on the Bank of England. Unable to use the five pound notes in daily transactions, customers presented them to the Bank to be exchanged into gold: six million pounds in gold was paid out in just three days. In ‘War and the Financial System’, Keynes denounced the banks for exacerbating the panic in the City: ‘The banks revived for a few days the old state,’ he wrote, ‘of which hardly a living Englishman had a memory, in which the man who had £50 in a stocking was better off than the man who had £50 in a bank.’

In order to slow down the collapse, the British state was forced to make novel interventions in the economic system. Not only did the crisis threaten mass bankruptcy and the freezing of domestic and international credit, it also jeopardised the state’s ability to raise funds to pay for the coming war. On 2 August, a moratorium on payment of bills of exchange was declared to give breathing space to the accepting houses and other financial firms. This pushed back the due date of payment on bills of exchange, so that defaults would stop and banks could shore up their assets. Emergency moratoria were declared in more than thirty countries across the world – in Nicaragua, Ecuador, Uruguay, Egypt, Romania and Cyprus in the first two weeks of August alone. In Britain, the bank holiday was extended for three more days and interest rates were raised dramatically. The Treasury had to improvise: in an effort to ease the credit crunch, it decided to print additional paper notes – so-called ‘Bradburys’ (the name of the Treasury official who signed them was John Bradbury) – to get more money into circulation. Now that war had been declared it was even less likely that the City’s banks would receive payment for prewar bills of exchange, so the Bank of England offered to take £120 million of unmarketable assets off their books. And to put the merchant banks back in business, the Bank advanced cash to allow them to meet their obligations on bills they’d accepted before the war began.

This was a bailout of unprecedented proportions, with the Bank of England, backed by the Treasury, handing out financial assistance equivalent to 40 per cent of all public expenditure. The state had never assumed responsibility on this scale for managing economic crises or guaranteeing specific economic outcomes. But it was a role it would quickly grow into. The response of the Treasury augured a revolution in the way countries took control of the national wealth, as power over the regulation of economic and financial processes moved from private bodies, like the Bank of England, to government ministries – a process dramatically accelerated by the enormous costs and logistical challenges of waging total war.

These​ early forays into emergency economic management were largely successful: there was no run on the banks when they reopened on 7 August, and by November the moratorium was lifted. By the end of the summer, the City had essentially been saved, although it did not resume many of its international financial activities for the duration of the war, and the Stock Exchange remained closed until January 1915. Having helped the banks back to solvency, the government could turn to them to finance the war, issuing a deluge of war bonds and Treasury bills to be purchased by the now flush financial institutions. Unlike the crisis of 2008, the financial collapse of 1914 did not lead to a lingering recession: the stimulative effects of mobilisation and war production allowed Britain to put the summer’s crisis quickly behind it.

This is one of the reasons that the 1914 financial crisis has been almost completely forgotten. This act of historical amnesia is one of the themes of Richard Roberts’s Saving the City, the only major book-length treatment of this topic to appear since 1915. On Roberts’s account, people at the time didn’t really distinguish between the distinct crises of August 1914, financial, military and political. Given the relatively short length of the economic crisis, memories of its dislocations didn’t have time to take root. We are prone to forget near misses, and often underestimate the contingency of outcomes: ‘Had the worst fears been realised,’ Roberts writes, ‘the failure of scores of brokers and jobbers, wholesale insolvency among the merchant banks, runs that closed major joint-stock banks – the financial crisis might have assumed the magnitude and prominence of a financial catastrophe.’ And the First World War might have played out differently.

Historians too have tended to overlook the 1914 crisis. One reason, according to Roberts, is that it doesn’t correspond neatly to standard typologies. On the well-known model of Charles Kindleberger (building on the work of Hyman Minsky and Irving Fisher), a crisis occurs after an exogenous shock to an economic system gives rise to an unsustainable bubble of speculative activity, which, when it bursts, precipitates a mad race for cash. There’s a long list of crises in Europe and America that fit this model – 1763, 1873, 1929, 1987 – but 1914 doesn’t, which has led some to lump it together with other ‘pseudo-financial crises’ that are of less interest than the textbook examples. Since 2008, however, those in search of economic lessons from the past have begun to investigate these less well-known crises. And there are certain similarities between the subprime meltdown of 2008 and the crisis of 1914: both required massive state bailouts to institutions that had issued and insured unwieldy financial instruments, which had been left to rot as ‘toxic assets’ on their balance sheets. Both also ended in paralysing credit crunches. Yet the fundamental character of each crisis was distinct: in 1914, it was one of liquidity, as Roberts points out; in 2008, one of solvency. What is also unique about the 1914 crisis was the speed and effectiveness of the state’s response, which might be thought surprising, given how little experience countries had in dealing with economic difficulties on this scale.

For many contemporaries, the events of the summer of 1914 cast doubt on one of the strongest and most persistent myths of the day, one that is as popular now as it was then: that financial and commercial interdependence prevents nations from going to war. This belief was expounded most powerfully in 1909 by the journalist and pacifist Norman Angell, who in his bestselling book The Great Illusion argued that the emergence of a highly internationalised system of finance made warfare between economically ‘civilised’ nations too costly to be worth pursuing. The German invader, should he come, could loot as much as he wanted from British factories, but in so doing he would disrupt a major source of profit for the financiers and investors at home who now generated much of Germany’s wealth. In the interconnected world, to weaken one’s neighbour was to weaken oneself. Military might had given way to financial co-operation as the surest path to national prosperity: ‘Banking done by telegraphy,’ Angell wrote, ‘is destined to transform the mind of the statesman.’ (That the emergence of this global economic system had been facilitated by Britain’s overseas imperial presence and the strength of its navy was something he didn’t dwell on.) The supposedly pacifying effects of international economic activity had long been a common theme of European political thinkers. In 1748, in De l’esprit des lois, Montesquieu had argued that trade was a powerful civiliser of barbaric peoples: ‘Wherever there is commerce,’ he wrote, ‘there the ways of men are gentle.’ This trope, reiterated by many of the major writers of the Enlightenment (particularly in Scotland) and pilloried by Marx (‘Das ist der doux commerce,’ was his sardonic description of Europe’s imperial expansion), became a kind of national myth in Victorian Britain.

The same vision held considerable appeal for internationalist movements throughout the 20th century, and continues to do so today in the world of the pax Americana. When it first became clear that Russia intended to annex Crimea, many were quick to remind Putin of the anachronistic and self-defeating nature of military conquest in an age of globalisation: ‘What he needs to understand,’ an unnamed senior member of the Obama administration said, ‘is that, in terms of his economy, he lives in the 21st-century world, an interdependent world.’ For those who lived through the crisis of 1914, the folly of this kind of thinking was clear. By the autumn, it was obvious how wrong Angell had been to assume that the threat of a global capitalist crisis would prevent states from taking up arms. The emergence of a world economy, far from doing away with war, merely meant there was far more at stake when finally it came.