World Tensions.
The international banking system has been subject to unusually severe strains this year, yet no major breakdown has occurred. Early in the year, the depression, which had been severe in the United States during the final months of 1937, spread to other countries. In March, Germany seized and amalgamated Austria. The increased political tension manifested itself in an increased flow of gold to the United States. In May, France had another of her periodic crises. Its solution, though temporary, brought some return of French funds from abroad, thus causing strains in other financial centers. Summer months witnessed a general easing of credit and revival of security markets spreading from the United States. In September, the European war scare precipitated the sharpest financial crisis of recent years, with unprecedented gold flows and a tightening of credit.
Recovery from this crisis was exceedingly rapid. But afterwards the London market was subject to pressure for the rest of the year. In November, France again reached the crisis stage. Again a political reorganization and new economic decrees promised financial stability at home. Again financial pressure appeared in neighboring markets, especially London. Germany and, to some extent, Italy are financially insulated from the rest of the world by their rigid economic controls; but there is increasing evidence of inflation at home and lack of available foreign exchange. Everywhere in Europe, the necessity for increased armaments is causing a heavy strain on government finances and diverting capital from industrial and commercial uses. In the Orient, the continuance of the war has caused a depreciation of Chinese exchange and great financial strain in Japan. Thus far in South America, the fall of world agricultural prices has not brought serious financial difficulties, but the socialistic program of Mexico has led to a heavy depreciation of her currency.
Banking Conditions.
The changes in banking conditions during the first months of the year in those countries not subject to close economic controls were those typical of a period of mild depression. Gold reserves of the Central banks remained practically constant, deposits in commercial banks contracted somewhat, money rates declined. Security prices continued to drop for the first three months, then rose again. This change in trend of security prices followed that of security prices in the United States. There the Government, during April, took strong steps to expand credit. Gold stocks formerly sterilized were restored to the monetary system, reserve requirements for commercial banks were reduced, and the Government speeded up its spending program. The effects of the new funds showed themselves first in the security markets, and the rise of prices there induced the price rises in other centers.
The invasion of Austria by Germany produced surprisingly little direct effect in the financial centers. Security prices declined but little, money rates were hardly affected. However, the drainage of gold to America, which had nearly ceased at the end of 1937, again assumed substantial proportions. In March, $52,000,000 net were shipped to New York; and in April, $71,000,000. Until August, the level of March was maintained. Exchange rates began to decline also. The pound, which had risen in the first two months of the year, dropped slowly. It was $5.00 in February, $4.98 in March, and $4.96 in June. The franc declined from 3.3 cents in February to 3.1 cents in March. Although these are certain signs of strain, the pressure was low for a period of such great political upheaval.
French Financial Situation.
The French financial situation has been a menace to international stability for many years. The difficulty arises not from a lack of gold reserves to support the currency, but from the fact that government expenditure is too large in proportion to income. The flight of capital abroad and the short working week decreed by the Government makes intensive use of existing capital impossible. As a result, the level of incomes is low. Although taxation is heavy, borrowings have absorbed practically all the new savings. Government estimates place the national income for 1938 at 220,000,000,000 francs. Government expenditures on 137,000,000,000 francs, of which 55,000,000,000 francs are borrowed. Such a condition cannot long continue without serious inflation. In fact, though world prices were falling. French prices were rising rapidly. The index of wholesale prices (1913 = 100), which had averaged 581 in 1937, stood at 636 in January 1938 and rose to 654 by May. The crisis of March emphasized the necessity for further outlays for national defense. The political crisis followed with a change in government. New economic decrees were promulgated on May 3 and 4. These set a lower limit to the exchange value of the franc of 179 to the pound sterling.
The exchange market was strengthened further by various inducements designed to stimulate exports and to encourage foreign tourists. Taxes were increased, and the general financial structure of the Government was strengthened. As a result, some $400,000,000 to $500,000,000 returned to France during the next month. Although much of this came from London, other centers were affected. Switzerland lost $30,000,000, and Belgium $132,000,000. The Dutch exchanges weakened, and funds were withdrawn from New York. This latter movement did not reverse the gold flow because the United States had a substantial excess of exports throughout this year. However, this movement of funds was short-lived. Later the flow reversed, production did not increase, and the exchanges sank again.
German-Czechoslovakian Situation.
By August, tension in Europe over the German-Czechoslovakian situation was strong. This time the financial centers were severely affected. Gold drainage increased. The United States received gold imports of $166,000,000 in August. Most of this came through London, so that the pressure was heaviest on that market. The Exchange Equalization funds proved adequate to the crisis, and rates broke only a little. In September, the crisis was acute. In the single month $521,000,000 in gold moved to the United States. France and Belgium moved gold to London, 'neutral' countries called their funds home. Exchange rates sagged. The London-New York rate declined to $4.61 at the height of the crisis, and the Paris rate to $2.64 cents. German exchange was, of course, unaffected. Interest rates on the open market rose. In France, the Bank of France raised its discount rate from 2 per cent to 3 per cent. Security prices broke sharply. In London, the stock index dropped by 14 per cent, in France by 6 per cent. Government bonds reacted violently. Note issues of the Central banks expanded — in some countries by 25 per cent in the course of two weeks, partly to meet the expenses of mobilization, partly to meet demands for hoarding.
Two weeks later, the crisis had passed. But although the immediate reaction carried conditions in the money markets to the state prior to the crisis, afterwards they drifted downward. Security prices in London and several Continental exchanges dropped slowly, although in the United States they moved upward. New issues of securities which had practically disappeared during the summer continued to be absent. The pound declined slowly but steadily. At the end of the year it was $4.62.
November Crisis in France.
In France, the financial situation again arrived at a crisis in November. Expenditures for defense were imperative. Prices were moving upward — the index of wholesale prices reached 663 in October, production was declining, the exchanges were weak. Again a new and more conservative government was organized, new economic decrees increased the working week and made conditions for the return of capital favorable. Taxes were increased; government expenditures, other than for defense, were reduced. The franc was settled at a new level, approximately 2.64 cents. The gold reserves of the Bank of France were revalued at the new level for the franc. At first, serious labor troubles threatened. At the end of the year, the position of the Government was secure, and funds were returning again from abroad. This intensified the financial difficulties of London.
Germany's Lack of Foreign Exchange.
In Germany, rigid controls prevent statistics from revealing the true conditions. The gold reserve continues to be negligible, the official exchange rate pegged by licensing. Government expenditures are very heavy both for public works and for defense. The note circulation of the Reichsbank has risen 35 per cent and bank deposits by 15 per cent. The production of consumption goods has declined. Yet official indexes show no rise in prices. There are, however, other indications of scarcity of goods and inflation. The result of the lack of foreign exchange to provide needed imports has led to the development of new financial techniques. The Aski mark, whose value is changed from county to county at the will of the Government, is one such device. These marks are supplied only to individuals buying goods from Germany and have the effect of reducing German prices to foreigners. Another device is the extension of long-term credits to buyers of German goods in countries with which Germany has clearing agreements. Since these agreements usually provide for payments into clearing accounts at the time the goods cross the border, not when they are paid for, Germany is actually receiving increasing loans from abroad. Meantime, her earlier creditors are becoming restive. The Standstill agreement this year was renewed only for three months from November.
In the Orient.
In the Orient, the Chinese exchange rate has broken badly. The Shanghai dollar is now worth only a little more than half what it was a year ago. The break began in March, but became rapid during the summer. In the fall, it was relatively firm.
In Japan, the exchanges have been supported by the use of the gold reserve. Gold exports of $140,000,000 were sent to the United States alone; $100,000,000 was transferred from the gold reserve of the Bank of Japan to the exchange fund in July, leaving the Bank with only $164,000,000. These reserves will not provide payment at the present rate for the import surplus of more than six months. The necessity for war materials and raw materials in general would hardly allow for further curtailment of imports while the expansion of exports with the present state of world trade and opinion will be difficult. Meantime, every evidence of inflation is present. Bank note issues increased 25 per cent during the year, and bank deposits 20 per cent. Prices rose in spite of rigid controls. The war is absorbing nearly 81 per cent of all Government expenditures and nearly three-quarters of these are raised by borrowing. Although other demands for capital are removed from the market by Government embargo, the rising cost of living coupled with falling production will make it difficult for even this source to provide the necessary funds much longer without currency depreciation.
South America and Mexico.
In South America, the year has been one of relative financial stability. The currency of Chile remained unchanged in value while that of Brazil and of Colombia rose a little. The Argentine peso dropped from 29 cents to 23 cents in the course of the year. The decline was occasioned in part by the great decline in the value of agricultural products. In November, the Government raised its official selling rate for exchange while keeping its buying rate unchanged. The profits will be used to help in the fixing of prices of agricultural products. Mexican exchange dropped rapidly from 27 cents to 20 cents after the Government seized the properties of foreign oil companies in March. Oil production declined to one-fourth its former amount, and with it the value of the Mexican export trade.
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