Volume 2 — While Germany's Trade and Credit Are Holding Their Breath

By J. Laurence Laughlin

[From THE NEW YORK TIMES, March 9, 1915.]

Professor Laughlin, who makes the following remarkable study of the German financial emergency, was lecturer on political economy in Berlin on the invitation of the Prussian Cultur Ministerium in 1906, and since 1892 has been head of the Department of Political Economy in the University of Chicago. He is acknowledged to be one of the foremost American economists and the views here expressed are based on wide information.

In a great financial emergency conditions are immediately registered in the monetary and credit mechanism. Although the German Government and the Reichsbank had obviously been preparing for war long before, as soon as mobilization was ordered there was a currency panic. The private banks stopped payment in gold. Crowds then besieged the Reichsbank in order to get its notes converted into gold. Then the Banking act was suspended, so that the Reichsbank and private banks were freed from the obligation to give out gold for notes. At once all notes went to a discount in the shops as compared with gold. Thereupon, in summary fashion, the Military Governor of Berlin declared the notes to be a full legal tender and announced that any shop refusing to take them at par would be punished by confiscation of goods.

In Germany, as is well known, the main currency is supplied by the Reichsbank, covered by at least 33-1/3 per cent. in gold or silver, and the remaining two-thirds by commercial paper. Immediately after the outbreak of war there was a prodigious increase of loans at the Reichsbank, in consequence of which borrowers received notes or deposit accounts. Usually transactions are carried through by use of notes, and not by checks, as with us. On July 23, 1914, the notes stood at $472,500,000; deposits at $236,000,000; discounted bills and advances at $200,000,000. On Aug. 31 notes had increased to $1,058,500,000; deposits to $610,000,000; discounts and advances to $1,113,500,000, (by October this amount was lowered to about $750,000,000.) On the latter date the specie reserve stood at $409,500,000, or more than the legal one-third. Loans had been increased 556 per cent.; notes 223 per cent., and deposits 258 per cent. In short, $586,000,000 of notes had been issued beyond the amount required in normal times, (July 23.) Clearly this additional amount was not required by an increased exchange of goods, but by those persons whose resources were tied up and who needed a means of payment. The same was true of the large increase of deposits which resulted from the larger loans. A liberal policy of discounting was followed by which loans were given on the basis of securities or stocks of goods on hand. That is, non-negotiable assets were converted into a means of payment either in the form of notes or deposit credits.

At this juncture there was created a currency something after the fashion of the Aldrich-Vreeland emergency notes in this country. War credit banks were established by law to issue notes (Darlehnskassenscheine) in denominations of 10, 15, 20, and 50 marks as loans on stocks in trade and securities of all kinds, and were charged 6-1/2 per cent. interest. The goods on which these notes could be issued were not removed, but stamped with a Government seal. While not a legal tender, the notes were receivable at all imperial agencies. On securities classed at the Reichsbank as Class I. loans could be made up to 60 per cent. of their value as of July 31; as Class II., 40 per cent.; on the other German securities bearing a fixed rate of return, 50 per cent.; on other German securities bearing a varying rate of return, 40 per cent.; on Russian securities, a lower percentage. These institutions, therefore, took up some of the burden that would otherwise have fallen on the loan item of the Reichsbank. Hence the Reichsbank account does not show the whole situation.

To this point the methods followed were much the same as in London. Then came unusual happenings. In London for a few days the banks had wavered as to maintaining gold payments, but only temporarily. In Berlin drastic measures were undertaken to accumulate gold in the Reichsbank. Vienna reports it to be well known that Germany had been for eighteen months before straining every nerve to obtain gold. Whatever sums of gold were included in the so-called "war chest" in Spandau (said to be $30,000,000) were also deposited with the Reichsbank. Gold was even smuggled across the borders of Holland on the persons of spies. Urgent demands were made upon the people to turn in gold from patriotic motives. In this way over $400,000,000 of gold was gathered by July, 1914; and by the end of the year, after five months of war, it had risen to $523,000,000. Was Germany to maintain gold payments as well as Great Britain?

Evidently not. Gold was not given for notes on presentation. For purposes of exchanging goods the notes were in excess. Inconvertible, they must go to a discount with gold or with the money of outside countries using gold. But in order to get imports from other nations, like Holland, Scandinavia, and Denmark, Germany must either send goods, or gold, or securities. German industries, except those making war supplies, were not producing over 25 per cent. of capacity, and many were closed. The Siemens-Schuckert Works, even before the Landsturm was called out, lost 40 per cent. of their men on mobilization. The Humboldt Steel Works, near Cologne, employing 4,000 men, were closed early in August, as were nearly all the great iron works in the district between Düsseldorf and Duisburg. Probably 50 to 75 per cent. of the workers were called to the colors. The skilled artisans were in the army or in munition factories; the railways were in the hands of the military; and the merchant marine was shut up in home or foreign ports. There were said to be 1,500 idle ships in Hamburg alone. Few goods could be exported. Gold was refused for export, of course. A serious liquidation in foreign securities had been going on long before the war. Some foreign securities must have still remained. However that may be, a claim to funds in Germany (i.e., a bill drawn on Germany) was not redeemable in gold, and it fell in price. In normal times a bill could not fall below the shipping point in gold, (par with us for 4 marks is 95-1/4 cents in gold;) but, since gold could not be sent, exchange on Germany could fall to any figure, set only by a declining demand. Already bills on Germany have been quoted in New York at 82, showing a depreciation of German money in the international field of about 13 per cent. Likewise, as early as the first week of September, the Reichsbank notes were reported at a discount of 20 per cent., and as practically non-negotiable in a neighboring country like Holland.

The inevitable consequence of a depreciated currency must be a rise of prices, usually greater than the actual percentage of depreciation. To meet this situation there came a device possible in no other commercial country. The Government fixed prices at which goods could be sold. This mediaeval device could be enforced only in a land where such State interference had been habitual, and, of course, could give to the notes the fictitious purchasing power only inside the country. After the Christian Science fashion, one had only to believe the notes were of value to make them so; but in the cold world outside German jurisdiction their value would be gauged by the chances of getting gold for them. Here, then, we find Germany in all the mazes of our ancient "greenbackism," but still in possession of a large stock of gold. As soon as the war ends she may be able to return to gold payments at an early date—very much as did France after the ordeal of the Franco-Prussian war of 1870-1871.

In the present war conditions, however, largely cut off from other countries, (except some small trade with Switzerland, Holland, Denmark, and the like,) all ordinary relations which would influence German credit and industry must be counted out. There is no comparison of her prices and money with those of other countries in a free market, or with even a limited transportation of exports and imports. All commercial measurements are suspended for the time. Trade and credit are holding their breath. How long can they do it? Germany may have food enough; but how long can the stoppage of industry go on?

Moreover, attention must be called to one momentous thing. We are seeing today, under military law, the greatest experiment in socialism ever witnessed. All wealth, income, industry, capital, and labor are in the direct control and use of a military State. Food, everything, may be taken and distributed in common. I think never before in history have we had such a gigantic, full-fledged illustration of socialism in actual operation.

In the meanwhile, even though food may be provided, the reduction of industry in general has cut incomes right and left. That is, fewer goods are produced and exchanged. But goods are the basis of all credit. The less the goods exchanged, the less the credit operations. Nevertheless, the extraordinary issues of banknotes, the increase of deposits, as a result of quintupling the loans, means that former commitments in goods and securities cannot be liquidated. That is, the enormous increase of bank liabilities, to a considerable and unknown percentage, is not supported by liquid assets. These assets are "canned." Will they keep sweet? There is no new business, no foreign trade, sufficient to take up old obligations and renew those which are unpayable. Lessened incomes mean lessened consumption and lessened demand for goods. Hence the credit system is based on an uncertain and insecure foundation, dependent wholly upon contingencies far in the future which may, or may not, take the non-liquid assets out of cold storage and give them their original value.

Moreover, apart from definite destruction of wealth and capital in the war—which must be enormous, as represented by the national loans—the losses from not doing business in all main industries during the whole period of the war (except in making war supplies) must be very great. As it affects the income and expenditure of the working classes, it may be roughly measured by the great numbers of unemployed. If they are used on public works, their income is made up from taxes on the wealth of others. Luxuries will disappear, and not be produced or imported. Incomes expressed in goods, or material satisfactions, have been diminished—which is of no serious consequence, if they cover the minimum of actual subsistence. The prolongation of the war will, then, depend on the ability to provide the supplies for war.

The need for a medium of exchange is oversupplied. The lack is in the goods to be exchanged. The enormous extension of German note issues does not, and can not, diminish. In this country the expansion of credit and money immediately after the war (manifested by the issue of Clearing House certificates and emergency banknotes) has been cleared away by liquidation. In Germany the "canned" assets behind the depreciated currency cannot be liquidated until the end of the war. And their worth at that time will depend much on the future course of the war and the terms of peace. If German territory should be overrun and the tangible forms of capital in factories and fixed capital be destroyed, much of the liquidation might be indefinitely prolonged. Whatever of foreign trade is permanently lost would also increase the difficulties.

In a great financial emergency nearly every country has, at one time or another, been tempted to confuse the monetary with the fiscal functions of the Treasury. To borrow by the issue of money seems to have a seductive charm hard to resist. Lloyd George established a new precedent for Great Britain by issuing nearly $200,000,000 of Government currency notes, but this was done to provide notes for the public instead of coin (£1 and 10s.) and made unnecessary any emergency issues by the Bank of England, and a large gold fund has been accumulated behind them so that they are convertible. In Germany it does not seem likely that the Treasury notes will be largely used (having increased from $16,500,000 to about $200,000,000) as a means of borrowing, since the new loans are being issued in terms of longer maturities.

J. LAURENCE LAUGHLIN.