1939: International Banking And Finance

World Tensions.

The international money and capital markets during 1939 were subjected to the strains accompanying another political crisis in the spring and to the adjustment to a war basis in the fall. Such is the effectiveness of controls today, however, that the war itself caused none of those spectacular dislocations which were associated with the outbreak of the World War. In the spring crisis, money rates had tightened and security prices broken but by summer the tension had eased and only the continued drain of gold to the United States showed the underlying uneasiness. The foreign exchanges, subject to the influence of the equalization funds, moved within narrow limits. Upon the outbreak of war the pound sterling was allowed to seek its own level, carrying with it certain of the other exchanges, but many of the rates held firm. Meantime, a rigid mechanism for control was put in force to prevent the flight of capital abroad and to consolidate the control of foreign balances in the hands of the Government. Even the sale of securities at home and the issuance of new securities were rigidly regulated. These regulations are of such a nature that it is doubtful whether the merchant bankers and acceptance houses, long the pride of the London market, will survive. Commodity prices were subjected to government control as well as the movements of trade in international and, to a less extent, national markets. Freedom of economic enterprise was so drastically curtailed as to leave great doubt that it can be reestablished after war ends. In France, economic conditions had improved during the spring but freedom of enterprise was already severely curtailed. The outbreak of war increased these restrictions as in the case of England. In Germany, financial pressure had been increasing with inflationary tendencies becoming more and more evident. The neutral countries in Europe were severely affected, but in South America currencies were unusually steady all year, except for Mexico. In the Orient, the strain of their own war showed increasingly. The yen depreciated rapidly during the fall but was eventually pegged to the dollar. The Chinese currency fell to half its former value.

British Financial Situation.

During the first eight months of 1939, conditions in the international money markets had changed only gradually except at the time of the Czecho-Slovakian crisis in April. In England, the money markets were easy. Bank rates remained at 2 per cent. Open market rates for bankers acceptances which averaged .91 per cent in 1938, were .55 per cent in January, rose to 1.40 per cent at the crisis and declined to .79 per cent in July. Demands upon the money market from commercial borrowers were small, but Treasury bills appear in ever increasing volume. Security prices drifted downward. For bonds, the index (1921 = 100) which was 116 in January dropped to 111 in April and stood at 113 in August; the index of common stock prices (1926 = 100) was 78 in January, 75 at the crisis and 76 in August. The commodity price index (1930 = 100) dropped from 93 in January to 91 in August. The foreign exchange rates were steady at $4.68. Yet underneath this appearance of stability, strains were developing. Expenditures for national defense mounted. The 1938-39 budget was £400,000,000. In April, the 1939-40 budget estimate was £580,000,000. Shortly thereafter it was raised to £630,000,000 and in July to £730,000,000. The Government expected to raise £500,000,000 of this sum from borrowings. The total floating debt had been £1,037,000,000, at the end of December 1938, and the total national debt £8,417,000,000. On the eve of the war the floating debt was £1,128,000,000 and the total debt £8,485,000,000. Meantime, Exchequer balances dropped from £3,000,000 to £2,500,000. Exchange rates had been held steady at $4.68 by use of the Exchange Equalization Fund. Even as early as Jan. 5, a lean on forward dealings in gold had been imposed. On Jan. 6, £350,000,000 (market value) were transferred from the Bank of England to the Exchange Equalization Account. On March 28, the relations of the Exchange Equalization Account and the issue department of the Bank of England were reorganized. Gold and securities at the Bank of England were to be carried at current market prices. Since the gold had been carried previously at the value determined by the old content of the sovereign, the gold stocks became more valuable in pounds sterling. The act, further provided for weekly revaluation and any excess or deficiency between the amount of notes outstanding and the value of gold and securities was to be made up by a transfer of gold or securities between the Account and the Bank. The fiduciary issue of the Bank was raised from £280,000,000 to £300,000,000 at the time of the revaluation, the Equalization Account transferred £5,500,000 to the Bank. As a result of all these changes the gold reserve of the Bank which had been £326,000,000 at the end of 1938, dropped to £126,000,000 in January 1939 and rose to £226,000,000 in March. In July, it again increased to £246,000,000 by a further transfer of £20,000,000. At the opening of the war, it was £263,000,000. The liabilities of the Bank rose during this period also. The note circulation expanded to meet the needs of the increased payrolls occasioned by the armament program. The amount outstanding in January had been £464,000,000; it was £511,000,000 at the end of July. Meantime, partly through the Equalization Account, England continued to lose gold, chiefly to the United States. In the first eight months of the year some £295,000,000 net were exported. In 1938, only about £60,000,000 net had been lost and in previous years there had been net imports. Thus the underlying currency situation had become unfavorable even before the outbreak of war although interest rates were still maintained at a low level.

French Situation.

In France, conditions improved rapidly during the early part of the year. The increase in the working week made increased production possible and unemployment declined. The index for production (1928 = 100) which had stood at 86 in December 1938, was 100 in June 1939. Meantime, wholesale prices dropped, the index (1913 = 100) declining from 689 in January to 674 in August. Security prices were relatively stable; bond prices rose from 83 in January to 87 in April and then declined again to 83 in August, while stock prices moved somewhat erratically but were as high in August as in January. With the increases in business, government finances were improved. For the first seven months of 1939, receipts amounted to 31,240,000,000 francs against 24,787,000,000 francs last year and the ordinary budget was balanced. With such improvement and the revaluation of the franc at a favorable level, capital poured back into the country. The gold reserves of the Bank of France, which were 87,265,000,000 francs at the end of December 1938, were increased twice by amounts of 5,000,000,000 francs each on April 20 and Aug. 3. In addition to the gold of the Bank, the French War Treasury contains 3,000 tons of gold. Naturally, under these conditions, exchange rates have been firm. But in France, too, strains were developing. Expenditures in preparation for war were large and increasing. The budget for expenditures on arms for 1939 was 46,032,000,000 francs compared to, 13,083,000,000 francs for 1935. The expected deficit for the year for the extraordinary budget was 28,212,000,000 francs. In spite of the fact that the price level was dropping, currency expansion was persisting at a rate which could not long be maintained without influencing the price structure. At the end of December, note issues were 110,935,000,000 francs; at the end of July, they were 123,239,000,000 francs. Interest rates became low. Bank of France rate was reduced to 2 per cent on Jan. 4, and remained there for the rest of the year, while the private discount rate which was 2.23 per cent in December 1938, declined to 1.95 per cent in August. Commercial bank discounts rose from 22,100,000,000 francs in January to 25,717,000,000 in July, and bank deposits from 33,444,000,000 to 36,650,000,000.

German Financial Situation.

In Germany, although the foreign exchange remained unchanged and prices were controlled, still signs of financial tension were abundant. Note issues of the Reichsbank, it is true, increased only from 7,816,000,000 reichsmarks in January to 8,989,000,000 at the end of July, but in the meantime the introduction of new forms of currency had reduced the significance of these figures. The strain in the finances of the Reich led early in the year to changes in financial arrangements. On Jan. 20, Dr. Schacht was relieved of the presidency of the Reichsbank and Hert Funk, Minister of Economies, took his place. Dr. Schacht had long stood as a bulwark against inflation. The new president insured the merging of Reichsbank with national policy and philosophy. In March, new types of currency were announced. Governmental agencies were allowed to pay for 40 per cent of their purchases with tax certificates which would entitle the holders to reduction in tax payments at future dates. One series provided reductions after they had been held six months, another only after three years. The contractors receiving these certificates were entitled to use them in turn for payments of 40 per cent of their purchases. These certificates thus provided for a new type of currency and also were an anticipation of future tax receipts. Holders were encouraged to hold them for long periods by increased benefits as the period advanced. The demand for the new currency proved to be great and by June, 1,000,000,000 marks are reported to have been issued. In June, the Reichsbank was finally completely consolidated into the Government. Shareholders were forced to transfer their shares into Treasury Bonds, or, for foreign holders, into shares of the Gold Discount Bank. For foreigners, the transfer meant little economic loss and entire control of the Bank passed to the Government. Shortly thereafter, the Bank formally dissolved the connection between note issue and holdings of gold and foreign exchange. The reserve had been negligible for some years. Thereafter the Bank ceased publishing figures for gold holding. The statements of the amount of the Government debt have been withheld for some time, but from what figures are available its rapid increase is evident. The new financial policies point to increasing pressure to obtain funds. The lack of the ordinary signs of inflation give evidence of the success of control; the income receiver is deprived of increasing portions of his income by prohibitions on the methods of expenditure instead of by a rise in prices.

Effect of European War on International Finance: The Belligerent Countries.

The outbreak of war brought abrupt changes in international financial organization. Control measures had been planned, and were put into operation so promptly that there was none of the disorganization that accompanied the outbreak of the World War, in 1914.

English Government Regulations on Foreign Exchange.

In England, the Bank of England raised its discount rate to 4 per cent (Aug. 26) and ceased selling gold to support the exchange. Thus the pound sterling was allowed to seek its own level but with sufficient interference from the exchange equalization fund to preserve an orderly market. The whole gold reserve was moved from the Bank of England to the exchange equalization account so that the gold position is no longer a matter of public knowledge. The limit for the fiduciary note issue of the bank was raised to £580,000,000. The free markets for foreign exchange and for capital were closed. Foreign exchange could be bought only through the Bank of England. A system of authorized agents was established to work with the Bank, the London Clearing Banks being chosen for the purpose. Although the merchant bankers and acceptance houses also have direct access to the Bank, they no longer can offer specialized service and, in fact, are at a disadvantage compared to the Clearing Banks. As a result, their business in exchange is expected to dwindle. All supplies of foreign exchange must be registered with the Government and exchange can be obtained only upon application to the Government. Naturally, as a result of these restrictions an extra-legal market in foreign exchange is growing. The security markets required special handling. On Aug. 24, after the raising of bank rate, minimum prices were imposed for all gilt edge securities. These minimum prices were the bid prices at the close on Aug. 23, and trading was confined to the minima, the volume being small. Other securities declined moderately in price for most of the week. Trading for the account was discontinued for the duration of the war. The next week, the holdings of foreign securities were mobilized. All British residents (whether citizens or not) were required to register with the Government all holdings of foreign securities. Thereafter, they could transfer such securities, under license, to other British residents, but only under exceptional circumstances to outsiders. These provisions together with the foreign exchange restrictions prevented the transfer of securities abroad. New capital issues, also, could be put on the market only with the agreement of the Government, which thus had wide control.

Effect on the Acceptance Market.

In the money market which was left free, rates jumped immediately. Bankers acceptances went from .79 per cent in July to 3.51 per cent in September, Treasury bills from .77 per cent to 3.23 per cent, and day-to-day money from .77 per cent to 2.72 per cent. The acceptance market was so badly affected by the breakdown of world trade that the Bank of England offered special assistance. All banks which had to take up acceptances while not receiving funds from clients overseas were allowed to discount such bills until they should receive remittances. They had to pay, however, a penalty rate of 6 per cent on these bills. The standstill agreements with Germany provided a special problem, as some £37,000,000 of acceptance credits were outstanding. Since Great Britain denounced the agreement at the outbreak of the war, these credits will never be repaid. The losses fell most heavily upon the acceptance houses and merchant bankers whose business was already dwindling because of the Government controls. The Government entered the commodity markets, also, to fix prices. August levels formed the basis of the new price system with allowances for changes in costs of production. This regulation was the serious blow to free competition. After the first impact of the war, the markets settled down to the new conditions rapidly. Bank rate was reduced to 3 per cent on Sept. 28 and to 2 per cent on Oct. 26. Note circulation of the bank which had jumped from £510,000,000 in July to £542,000,000 in September was £527,000,000 on Nov. 1. Rates in the open market declined. Bankers acceptances were 1.88 at the end of October and Treasury bills at 1.77. Meantime, the amount of Treasury bills mounted and the floating debt increased from £1,138,000,000 on Aug. 26 to £1,311,000,000 on Oct. 28. The value of the pound sterling fluctuated rapidly. At first, it dropped steadily until by the last week of September it reached $3.75. Then it recovered to $4.05, but by the middle of November it was dropped again and was $3.88 early in December.

France.

In France, the initial impact of the war was less serious than in England. Because of the general ease in the market and the excessive gold reserves, the Bank of France found it unnecessary to raise the discount rate. The Government had assumed dictatorial powers early in the spring. They now extended the controls, though, on the whole, they were less stringent than in England. Exporters were required to surrender their holdings of foreign exchange to the Bank of France and all sales foreign exchange deals were to pass through authorized dealers. French holders of other foreign assets were called upon to declare them before December and the purchase of foreign securities was forbidden. The raising of commodity prices above September limits were forbidden except for agricultural prices which were under the control of the Ministry of Agriculture. Limits were placed on increases in profits and wages, and taxes were increased. All of these decrees helped to protect French markets from the signs of war strain. However, like the pound sterling, the franc was allowed to decline. Its average value in September was 2.27 cents compared to 2.65, the value at which it had been held earlier in the year. By the end of November, its value was 2.21 cents. The Government authorized the withdrawal of all silver coins for 5, 10 and 20 cents and the substitution of paper in their stead. The Bank of France was authorized to place at the disposal of the Government 25,000,000,000 francs. Bills discounted at the Bank of France rose from 7,000,000 francs in July to 26,000,000 in August and remained at that level in September. The note circulation rose from 123,000,000 at the end of July to 144,000,000 at the end of September, while bank deposits rose from 16,000,000 to 18,000,000 francs. Prices of securities on the Bourse declined.

Germany.

For Germany, the information is very meager. Controls for most markets were in effect before the war so that emergency measures such as those applied in France and England were not necessary. Foreign exchange rates sagged a little from 40.1 cents per mark to 31.5 in September. Later, quotations were no longer available. The discount rate of the Reichsbank was maintained at 4 per cent. Reichsbank holdings of Treasury bills and securities increased and the note circulation rose from 8,900,000 reichmarks at the end of July to 10,100,000 at the end of September. Security prices rose slightly during August and September.

Effect of the European War on International Finance: The Neutral Countries.

Most neutral countries in Europe suffered immediate depreciation of the exchange values of their currencies, while a few others gained. Among the former were Denmark, Finland, Greece, Italy, Netherlands, Norway, Portugal, Spain, Sweden and Turkey, while to the latter group belong Belgium and Switzerland. By the end of November, even these two had sagged a little. The exchanges of all the British Dominions followed the fortunes of the pound. Thus depreciation has been widespread.

In South America, the war produced little effect. The exchange rates of most countries were unusually steady. Mexico formed an exception. In 1938, its rate had dropped sharply. Early in the year, it rose again only to drop in the summer from 20.0 to 16.8 cents. In September, it recovered again and at the end of November was 21.0 cents. The exchange, of course, reflects in part changes in the value of silver. Brazilian exchanges were supported in part by the financial agreement between the United States and Brazil. The United States Treasury provided $50,000,000 for the formation of a Brazilian foreign exchange fund and to aid in the formation of a central bank. The Export-Import Bank provided $20,000,000 for the unfreezing of commercial debts due to American exporters and granted $50,000,000 for the purchase of American manufactures. Brazil resumed the service of her debts to the United States and the exchange controls were modified.

Financial Situation in the Orient.

In the Orient, the year has been one of continued financial deterioration. For China, the exchange remained relatively stable from January to May at about 16 cents per yuan, but then dropped rapidly until in September it was 6 cents. At the end of November, it was 8 cents. Chinese exchange was supported to some extent by the United States' agreement to purchase Chinese silver, by a $25,000,000 credit by the Export-Import Bank and by the establishment of an exchange equalization fund of £10,000,000, one half contributed by the British Government. The break in June came partly as a result of the fall in the price of silver in the United States. In June and July, China adopted more stringent measures of exchange control. Meantime, note circulation in China has increased by 50 per cent in the last year and prices have mounted. The wholesale price index (1929 = 100) which had stood at 159 at the end of last year was 304 in August 1939.

For Japan, also, the exchange rate declined. It had been pegged to the pound and when sterling broke the yen was allowed to decline also. From 27 cents in July, it fell to 23 cents in September and was later pegged to the dollar. Gold imports to the United States continued in large volume. For the first nine months of 1939, they were $123,000,000. In spite of these exports, the reserves of the Bank of Japan and the Japanese Government were maintained intact. Note circulation increased from 1,031,000,000 yen in September 1938 to 2,461,000,000 in August 1939. Prices continued to rise in spite of continuing rigorous controls. The wholesale index (1913 = 100) rose from 182 in September 1938 to 210 in September 1939. War expenditures continued to press on Japan's financial resources. The budget for 1939-40 called for an expenditure of 8,870,000,000 yen of which 4,605,000,000 was for war purposes. Of this sum 5,650,000,000 is to be raised by borrowing an amount 1,000,000,000 yen higher than in the previous fiscal year. See also BANKS AND BANKING; BUSINESS; FINANCIAL REVIEW; UNITED STATES; WORLD ECONOMICS.