In international financial relations, three well-defined spheres of influence developed during 1940: the Sterling area, the Axis area and the Americas. Within each of these spheres relationships were strengthened but between spheres financial intercourse was severely restricted if it did not break down altogether. In the two belligerent areas, strenuous efforts were made to maintain the value of the currencies both in the foreign exchange markets and at home; in both ample signs of inflation were evident before the end of the year. In the Americas, foreign exchange problems became more pressing for the southern continent and, at the end of the year, inflationary tendencies were beginning to show themselves in the United States. An agreement among the American Republics reached in the spring provided for an Inter-American Bank to aid in the solution of common financial problems. In the Orient, the financial deterioration continued. There was a tendency for China to attach herself to the American sphere of influence. Japan, partly for geographical reasons, could not be included with the Axis countries and had to continue its financial independence. Throughout the world the evidence is accumulating rapidly that the new techniques can allay but not prevent the financial disorders attendant upon war.
Sterling Area.
At the beginning of 1940, the Sterling area had included a large portion of continental Europe as well as the British Empire (except Canada) and certain other portions of the Near and Far East. As Germany's conquests progressed, this area shrank and the Axis area expanded until practically only the British Empire remained. Through the extension of Sterling clearing arrangements and a general mobilization of the Empire's resources, notably through the Delhi Conference in the fall, the financial interrelations of the Empire were simplified and foreign exchange tensions eliminated. In these financial arrangements, Great Britain itself held, as always, the dominant position, and its financial position determined the position of the Empire.
Great Britain.
In Great Britain the financing of the war overshadowed completely all other elements in the financial markets. Nearly 60 per cent of the national income was absorbed by the government, 50 per cent for war purposes. Expenditures of this order have led in the past to immediate inflation. In this war precautions have been taken to prevent this result. Price fixing was introduced at the very outbreak of the war. Taxes were increased during 1940 to levels never before imposed. The basic rate for the income tax was 42.5 per cent and the excess profits tax was, in many cases, 100 per cent. Every business had to pay a national contribution tax. Luxury goods were taxed at 24 per cent and such goods as clothing and footwear carried a tax of 12 per cent. Yet in spite of the very substantial increase in income which these taxes yielded the deficit mounted. For the fiscal year ending March 1941 it is expected the deficit will be £2,107,000,000.
The British government experienced no great difficulty in raising the money to meet this deficit. In March, an issue of £300,000,000 long term bonds was floated at 3 per cent and in June a shorted term issue of indefinite amount was floated at 2½ per cent. By October, £286,000,000 of this second issue had been sold. In addition there was an intensive campaign to sell savings bonds to small investors. The savings bonds were to mature in ten years and were sold in limited amounts to private individuals. They carried the special provision that they could be cashed at any time on six months notice and they yielded 3.13 per cent. By the end of the year £337,000,000 had been sold. The sales of this type of bond had two purposes: they provided the government with funds and ensured, as ordinary bonds do not, that there would be an equivalent curtailment of consumer purchases.
The remainder of the funds was raised at short term and formed a floating debt. In spite of the increasing volume of these loans, the rate at which they were sold declined steadily. In September 1939, at the outbreak of the war, the rate on three month Treasury bills had risen to 3.23 per cent. In January 1940, it had declined to 1.09 per cent and in September 1940, it was 1.03 per cent. Thus there was no evidence of a shortage of funds at home.
The banking system, of course, reflected the effects of war finance. The note circulation of the Bank of England expanded but not spectacularly. In August it reached £610,000,000, on October 30 it was £592,000,000 compared with £527,000,000 in October 1939 and £511,000,000 in August 1939 before the war scare became intense. To provide coverage for these issues, the amount of securities and silver coin which could be held legally by the Bank was raised to £630,000,000 on June 12, 1940. Discounts of the Bank of England have remained at low levels while holdings of securities have increased only moderately from £128,000,000 in October 1939 to £153,000,000 in October 1940. Deposits at the Bank are lower than they were in 1939.
At the commercial banks changes were of somewhat greater magnitude. The Clearing Banks held £723,000,000 of securities in October 1940 compared with £603,000,000 in September 1939. Advances to customers declined from an average of £991,000,000 for 1939 to £934,000,000 in October 1940 while discounts rose from £255,000,000 to £373,000,000. Deposits which had been £2,278,000,000 in September 1939 were £2,661,000,000 in October 1940.
Security markets absorbed smaller amounts of private capital issues in 1940 than they had in 1939. In 1939, the amount of such sales averaged £8,754,000 per month, of which £2,305,000 were foreign. In 1940, April was the highest month with £6,652,000 and in no month after June were even £500,000 sold. Of these, almost none were foreign. Security prices were severely affected at the time of the conquest of France. Bond prices had risen from an index of 112 in December 1939 (1921 = 100) to 120 in February 1940. In June the index was 113 but it recovered to 119 in October. The decline in the stock market attendant upon the crisis in France was sufficient to invoke further restrictions upon trading in addition to those imposed last year. The index (1926 = 100) had dropped from 78 in March to 54 in June. Restrictions which suspended trading in a large list of securities were imposed June 18. By October the market had risen to 68 and on November 30, trading between residents of Great Britain was resumed for stocks on the list for which there was no market elsewhere.
The money markets were not affected by the disturbance in the security markets. As was the case with government loans, interest rates tended to decline. In October, the rate was 1.03 per cent for bankers acceptance and 1.00 per cent for day to day money.
Although the money and security markets were favorable on the whole, and in spite of the price controls, the financing of the government deficit did bring inflation. The wholesale price index (1930 = 100) which was 98 when war broke out reached 143 in October 1940. Prices of foods rose more than those of industrial materials. Retail food prices rose somewhat less rapidly. The index (1929 = 100) which averaged 92 for 1939 rose to 112 in October 1940. For the whole cost of living the index rose from 96 to 117.
Although the degree of inflation indicated was not alarming it was very substantial. Complaints concerning the administration of the price controls appeared. In September, Mr. Keynes urged the introduction of deferred certificates as a means of paying a portion of all wages so as to ensure curtailment of consumption. The proposal was not accepted, however, and the government continued to rely on voluntary saving and heavy taxation to curtail civilian consumption.
The government did take more active steps to prevent depreciation of the pound in the foreign exchange market. From time to time it added to its holdings of foreign funds by taking over foreign securities from its own nationals and repaying them in British bonds. The securities were sold in New York for the most part. New regulations were added to those promulgated in 1939 to prevent leakages particularly through the withdrawal of balances held in London by foreigners. Blocked Sterling accounts appeared in name for the first time in November. The British government entered into agreements with many neutral countries including South American Republics and the United States and with Canada providing for payments through 'special,' 'registered' and 'Sterling area' accounts. Within the Sterling area all payments were in Sterling so no foreign exchange was necessary. Special efforts were made to maintain the export trade.
As a result of all these measures the foreign exchange rate for Sterling was finally stabilized. The official rate was set at $4.035 per pound in March 1940 compared to the free rate of $4.61 in August 1939. The free rate reached its low point for the year in May at $3.27 but by the end of October it recovered to the official rate. This recovery was induced by the limiting of the free market through the new government restrictions.
France.
France, prior to the invasion, followed policies similar to Great Britain's. Price controls had been introduced in 1939 to prevent inflation. Taxation was increased in 1940 by raising the income tax and introducing new taxes on profits, dividends and wages. No indexes of prices are available for France to show the relative effectiveness of their attempts to prevent inflation but the financial data suggests that the situation in the two countries was similar. The note circulation of the Bank of France increased from 123,239,000,000 francs on July 31, 1939, to 170,853,000,000 francs at the end of May 1940 when the final offensive was under way. Gold reserves of the Bank were ample certainly until the actual invasion. At the end of 1939 they had been 97,267,000,000 francs. On Feb. 29, 1940, these reserves were revalued at 23.34 milligrams of gold 9/10 fine per franc. The 'profit' was used by the government to repay some 20,000,000,000 francs of its outstanding obligations to the Bank. At the same time 30,000,000,000 francs in gold were transferred to the stabilization fund. Thus, at the end of May the Bank still had 84,616,000,000 francs in gold. At the same time its outstanding advances to the government were 32,600,000,000 francs compared to 20,527,000,000 francs when war broke out. Open market bills held by the Bank increased from 9,396,000,000 francs at the end of September 1939 to 44,083,000,000 at the end of May 1940, and deposits increased from 18,038,000,000 francs before the war to 25,782,000,000 francs in May 1940. Most of these increases came in the final month.
Commercial banks showed similar changes. Deposits rose from 32,668,000,000 francs prior to the war to 46,064,000,000 in March 1940 (last figure). Discounts increased in the same period from 18,784,000,000 francs to 34,123,000,000 francs. Interest rates were not affected. Bank of France rate remained at 2 per cent throughout the period and the commercial rate (private rate in Paris) dropped from 2.70 per cent in September 1939 to 1.89 per cent in March 1940 and was only 2.00 per cent in May. The rate of exchange on New York sagged in the early months of the war from 2.61 cents per franc to 1.85 cents in May 1940 but rose to 2.01 cents just before trading was suspended. In June, France became virtually a part of the Axis area.
Axis Area.
German Controlled Countries.
The Axis area grew rapidly during the early months of the year. As country after country fell, their financial relations with the outside world were cut off and inflation appeared at home. By mid-summer exchange was no longer quoted in New York for Belgium, Bulgaria, Denmark, France, Netherlands, Norway, Poland and Rumania. The currency and banking arrangements of each country were reorganized to fit into the plan for the New Order in Europe. Portions of countries later to be completely consolidated with the Reich, such as Danzig and the Polish corridor, had their banking assets merged under an extension of the German banking system and reichsmarks were substituted for their former currencies. Countries which were occupied but to whom some autonomy was promised retained nominally their own financial system. In the Netherlands, for instance, the Netherlands Bank still functioned but German finance dominated its activities. When Germany purchased Dutch goods, Dutch citizens were paid by the Bank in florins while Germany reimbursed the bank by payments in marks or mark assets which were not then redeemable. This practice resulted in an increase in the note circulation of the Netherlands Bank of 226,000,000 florin from May 6 to Nov. 30, 1940. Such increases must be inflationary even though the fact is temporarily concealed by price controls.
Moreover all the occupied countries were forced to pay the expenses of the German armies of occupation. These payments more than absorbed all clearing balances and the mark assets supplied to the Central Banks.
Not only did German purchases dominate the situation within countries but relations between countries within the Axis area were also regulated through Germany, for all such payments had to pass through the Clearing Center in Berlin. A Dutch purchase from Belgium, for instance, had to be paid by a settlement between Holland and Berlin, and the proceeds would be put to the Belgian clearing account in Berlin. Thus financial relations within the occupied area were consolidated.
Germany.
Germany's own financial status showed signs of strain in the few figures which are available. Note circulation of the Reichsbank, which had been 8,989,000,000 of reichsmarks before the war, was 12,937,000,000 on Oct. 31, 1940. Holding bills discounted, including Treasury bills advanced from 9,358,000,000 to 13,069,000,000. The volume of securities held and of deposits changed but little. Figures for other banks are not available but the signs point to a condition which would have meant inflation under ordinary circumstances.
However, Germany's price controls and her rationing system were remarkably effective. The general wholesale price index (1913 = 100) rose only from 107 in October 1939 to 111 in October 1940 and the special index for industrial materials which should reflect war demands at their peak rose only from 126 to 131. Retail food prices (1913-14 = 100) rose more, from 122 in October 1939 to 133 in August 1940. The official foreign exchange rate sagged for the first time in many years but only from 40.097 cents per mark for December 1939 to 39.975 cents in October 1940. Bond prices, too, were very steady rising from an average of 99 in October 1939 to 101 in September 1940. The index for stock prices (1926 = 100) on the other hand, rose from 92 in October 1939 to 121 in September 1940. The Reichsbank rediscount rate was reduced from 4 per cent to 3½ per cent in April 1940, and the private discount rate declined from 2.75 per cent in October 1939 to 2.31 per cent in August 1940.
Italy.
Practically no information is available concerning Italy. The exchange rate is controlled and, like the German rate, has sagged only a little, from 5.044 cents per lire in November 1939 to 5.039 cents in October 1940.
American Sphere of Influence.
In the sphere of influence of the United States international financial relations were considerably strengthened. The development of the blockade abroad had interfered with the export trade of many of the countries. As a result pressure on the foreign exchange value of the currencies developed and import quotas had to be restricted. In the principal countries, Argentina, Chile and Brazil, the rates were maintained but in some of the smaller countries the rates broke. In Mexico and Uruguay, the rates declined in the first part of the year but recovered again in the fall. The United States attempted in every way to alleviate the situation. Trade relations were fostered. Loans were made both by the Import-Export Bank and by the Treasury's Stabilization Fund, especially to Argentina and to Brazil, a fact which accounts for the steadiness of their exchange rates. In the spring, a Pan-American Conference drafted a convention providing for an Inter-American Bank with capital of $100,000,000 and very broad powers to make loans both at long and short term and to provide mutual financial aid and advice. The convention had been ratified by a sufficient number of states to put it in force before the end of the year but it still awaited action by the United States Senate who must both ratify and grant the charter. In the late fall a rise in prices in the United States, particularly in the prices of foods, promised to make conditions of export more favorable for South America. (See also PAN-AMERICAN COOPERATION.)
Far East.
Japan.
In the Orient inflation has proceeded. In Japan, while gold holdings remained unchanged, note circulation of the Bank of Japan expanded from 2,687,000,000 yen in October 1939 to 3,556,000,000 yen in September 1940. Private deposits increased from 98,000,000 yen to 127,000,000 in the same period and discounts from 390,000,00 to 761,000,000. At the commercial banks deposits rose from 16,960,000,000 yen in August 1939 to 21,885,000,000 in August 1940. Interest rates remained unchanged. The wholesale price index (October 1900 = 100) rose from 293 in October 1939 to 308 in September 1940 while retail prices (1929 = 100) increased from 123 in August 1939 to 150 in August 1940. The exchange rate for the yen which was 23.441 cents at the end of 1939 was 23.439 in October 1940, held by the exchange controls and occasional shipments of gold.
China.
China was less favorably situated. The Chungking government incurred a deficit of £50,000,000 during the year. This sum was raised in part by an issue of gold bonds sold to individuals and in part by an issue of currency bonds sold to the commercial banks. These banks, in turn, issued notes against the bonds. As a result, note issues of the commercial banks increased by $1,000,000,000, Chungking, and the inflationary rise in prices was accelerated. Wholesale prices at Shanghai, the nearest center for which data is available, rose from 253 (1929 = 100) in August 1939 to 486 in August 1940 and the cost of living from 187 to 374 in the same period.
In the absence of effective exchange controls the foreign exchange value of the currency naturally dropped. As in South America the United States helped stabilize the rate through loans. One such loan was made in the spring and two in the fall. The rate for the Shanghai yuan dropped from 7.49 cents in December 1939 to 5.08 in May 1940, then recovered to 6.05 in July. It declined again to 5.21 in September, but as a result of the loan rose again to 5.68 in October. See also BANKS AND BANKING; WORLD ECONOMICS.
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