Historians, generally speaking, portray the years leading up to the First World War as
a time of mounting crises, and write that the war was a gradually approaching conflict
rather than a bolt from the blue.
But is that true?
Is it perhaps only retrospectively that we’d “seen it coming all along”?
The group that had perhaps the strongest interest in anticipating this war was the financiers
and investors, and that’s who I’m going to look at today.
I’m Indy Neidell; welcome to a Great War Special episode about Finance and the Great
War.
In the summer of 1914, the shape of the world economy was quite similar to that of, say,
the early 2000s.
Capital, labor, and commodities were mobile in levels comparable to those of the present.
Traffic across the Atlantic was huge.
Capital and migrants went west and raw materials and goods went east.
When the war came, it literally sank globalization.
Think of the millions of tons of shipping sunk by U-Boats.
In the war’s aftermath, revolutionary regimes emerged that were hostile to international
economics.
You had plans that replaced markets, protection replacing free trade.
Flows of people and capital dried up.
If the war was a gradually approaching conflict, then the financiers and investors in London,
the largest international financial market in the pre-war world, should certainly have
anticipated it, since it was they who had the most to lose in the event of war.
Warsaw financier Ivan Bloch estimated that European war would send the price of securities
down by 25 to 50%.
Norman Angell wrote similar stuff.
So if you were an investor holding bonds issued by one of the Great Powers, anything that
indicated a big war was on the horizon would be of serious concern, right?
And yet London didn’t see this war coming until very late in the day.
The Rothschilds were the most eminent firm in London, and they worked closely with family
in Paris and Vienna.
They dominated the bond market and a lot of what they held was European government bonds.
They stood to lose more than pretty much anyone else from the war, and their houses would
even be divided against each other, yet they were totally taken by surprise when the war
broke out.
Between July 23rd and July 28th, 1914, Lord Rothschild wrote repeatedly to his relatives
in Paris that the situation between Austria and Serbia would work out without war, that
Russia would not intervene, and that Britain would preserve peace in Europe.
It wasn’t until August 1st that articles like the following began to appear in the
Economist.
“The financial world has been staggering under a series of blows such as the delicate
system of international credit has never before witnessed, or even imagined... nothing so
wide-spread and so world-wide has been known before.
This... collapse of prices produced not by the actual outbreak of a small war, but the
fear of a war between some of the Great Powers of Europe.”
See that, “the fear of a war”, since it was still not certain who was going to join
the war.
That same day the New York Times headline was, “Czar, Kaiser, and King may yet arrange
peace”.
Movements in the prices of government bonds really reinforce the impression that the war
came as a total surprise to the people who had the biggest incentive to anticipate it.
Let me explain.
Political events were of primary importance to investors in 1914 because you could get
reliable news about them more often and more regularly than detailed economic data.
Nowadays we look at budget deficits, short-term interest rates, and stuff like that, but there
was much less economic data available then for making judgments on things like inflation
or risk.
Back then investors might have good info on things like commodity prices and exchange
rates, but there were no reliable figures for national output and income.
And in some monarchies and empires, annual budgets were not available or trustworthy.
So investors would infer the future of monetary policy from political events, which you got
daily in newspapers, telegraphs, and private letters.
And here are three main things they’d base their assumptions on:
1) A war would disrupt trade so governments would have lower revenues.
2) Direct involvement in a war would lead to increased spending, thus increased borrowing.
3) The war’s effect on the private sector would make it difficult for authorities in
the countries at was to keep converting bank notes into gold, so you ran the risk of inflation.
So any event that increased the likelihood of war should’ve affected the bond market.
War meant new bonds being issued, which would increase the bond supply so the price of existing
bonds would drop.
An investor who saw a major war coming would sell bonds in anticipation, so if the financial
markets saw the war coming then you’d see a decline in bond prices.
But this didn’t happen until the last week of July 1914, the week after the Austrian
ultimatum to Serbia.
Between July 22nd and July 30th, bond prices fell between 4 and 13% around Europe, but
this was not unprecedented, though the 5% drop on August 1st on the day Germany declared
war on Russia was.
But when the London market closed on the 31st, the scale of the war was still not yet apparent.
So even when the markets all over Europe were forced to close as the war spread, no one
was expecting Armageddon.
But then the financial crisis quickly exploded.
For example, British banks that had accepted foreign bills faced a general default when
the bills came due.
And all the foreign banks there took a ton of money out of the stock exchange.
The Economist called London, “a dumping ground for the liquidation for the whole continent
of Europe”.
By the end of the month trading had pretty much stopped and companies began to fail.
The London stock exchange was closed from July 31st, 1914 to January 4th, 1915.
Nobody saw a shock like that coming.
From 1914 to 1920, prices on British and French bonds decreased by nearly half, and they were
on the winning side.
The Bolsheviks just outright defaulted on Russia’s debt, and Germany and Austria had
hyperinflation.
The impact on, say, the Rothschilds was pretty devastating - they lost half of their capital
during the war.
Why was everybody caught napping?
It might be that financiers were the initial victims of the “short war” illusion.
Bloch and Angell had argued that the costs of a major war would render such a war either
impossible or brief, which was certainly not the case.
To everyone, it seems, even the financial wizards, the First World War came as a total
surprise.
You know how people who live in earthquake zones know that an earthquake is possible,
but the longer it’s been since one has happened, the less people think about the next one?
I think that might be the case with the markets and the war.
If this is true, then a lot of histories of the war are over-determining its outbreak
and inevitability, and far from being a gradually approaching conflict and a predestined cataclysm,
it was rather just a sudden explosion, and in that case an avoidable political mistake.
I can’t say for sure which school of thought is correct, but I thought it would be interesting
to present another side of the issue today.
The research for this episode was done once again by my old pal Scott Buchanan, and I
understand from him that he was reading a lot of historian Niall Ferguson, who is known
for contrarian and controversial views in regards to World War One.
Make of this episode what you will, it is certainly interesting.
If you’d like to see another viewpoint on a controversial topic, click here for our
episode on the Falkenhayn Controversy.