1940: World Economics

Shifts to War Economies.

During 1940 the fundamental adjustment of world economic conditions to a war basis continued. In the early months of the year there were general declines in production and prices from the speculative position reached in the closing months of last year. Later, in most countries war production got under way in real earnest and signs of inflation multiplied.

In Great Britain and the British Empire there was a complete mobilization of resources for war purposes and the greater portion of the national income was diverted to this end. Imports to Great Britain were heavy considering the constant attacks on shipping. Financial conditions at home were comparatively easy though price rises were substantial. The foreign exchange position of the currency was protected. Continental Europe was almost completely cut off from the outside world by the British Blockade after the fall of France in June. Germany proceeded to the consolidation of the production of these countries for war purposes and with plans for their future position in Europe. Germany's financial position remained relatively stable at home but in the occupied countries and those remaining neutral inflation became increasingly a menace. The United States, after the downfall of France, proceeded to press production of defense goods for itself and war materials for Britain. By the end of the year the increases in credit which accompanied this program began to show their effects on prices. In South America the breakdown of normal trade relations with Europe produced severe repercussions. Increased trade with Great Britain and with the United States in certain lines helped to fill the gap. The United States made further loans to several countries to finance trade and to stabilize currencies, and a convention providing for the Inter-American Bank was drafted. In the Orient, Japanese production was at lower levels than in 1939. During the first half year the export surplus continued but in the second half year foreign trade was sharply curtailed and imports exceeded exports. Foreign exchange remained steady, however. In China, trade became difficult but the value of imports increased rapidly compared with exports. Inflation at home was rapid but the depreciation in foreign exchange value of the currency was mitigated by loans from the United States. As the year closed it was abundantly evident that in spite of the improvement of techniques of management, this war, like that of 1914, would be accompanied by financial disturbances as well as the direct privations of the war itself.

Great Britain and the British Empire.

The main structure for the regulation of economic life in Great Britain during the war was laid down in 1939. In 1940 its scope widened and its enforcement was more strict. As the countries of the continent fell into enemy hands, trade became more restricted and the tonnage of vessels available for foreign trade shrank as sinkings multiplied. The intensification of bombing tended to curtail domestic production and to disrupt transportation. Under these circumstances government control had to be strengthened. The primary object was to produce all possible material for the war while maintaining a minimum standard of living for the civilian population. Otherwise, as great liberty as possible was given to the citizens, much more than was the case in Germany.

Production continued to be shifted from consumers' goods to war materials. Although indexes of production were no longer published evidence of the magnitude of the shift is given by the fact that retail stores were allowed, by the end of the year, to stock only 25 per cent as much of unessential goods as in 1939. Rationing of food supplies was extended little by little. Even by the end of the year, however, these restrictions applied to raw food purchased, not to purchases at restaurants. Such a system of rationing was much less stringent than the German, but led to criticisms of the government's policies. The poor do not purchase extensively at restaurants so the system allowed the rich to escape from the restrictions which the poor had to bear. Rationing, moreover, was applied only to the more essential and scarce foods. Local producers naturally escaped the restrictions as much as possible. Onions, for instance, which were restricted, ceased to be sold in London markets while sales of pickled onions, on which there were no restrictions, increased in volume. Again this situation brought criticisms. At the end of the year the system of rations was being extended, including a lessening of the amount of meat available for each individual.

Though the problems of civilian rationing were troublesome, difficulties in primary production were intense in many fields. Coal mines on the coast were practically abandoned while those in the interior flourished. Transportation facilities had to be conserved so that demand could not be spread. A similar situation developed in textiles. Plans were developed for providing a distribution of the proceeds of the industry to all companies so that those unfavorably situated because of the government planning should not be forced into bankruptcy. This lack of uniform distribution of orders, however, made necessary some unemployment. In mid-summer the number of registered unemployed amounted to some 750,000 and increased to 835,000 by October. Next summer the plans for production will call for another million workers while the Army and Navy expect to absorb another million. There will be, therefore, a shortage of men.

The destruction of property by bombing became another crucial problem. At first, only the poor were compensated and then only for the loss of buildings, not of personal property such as tools. Later, an insurance plan was inaugurated whereby everyone contributed and everyone was protected at least for a minimum. Nevertheless, bombing came to be a serious threat to productive activity not only because of loss of plant but because of loss of time during air raid alarms. Workers were urged to stay at their posts even after the alarms were given.

Trade with outside countries was, of course, dependent on the tonnage of vessels which could be convoyed into British ports and given dockage. Bombing seriously interfered with trade by the destruction not only of vessels but also of docks. However, in the first ten months of the year imports were higher in value than during 1939. Part of the increase must be ascribed to the change in prices. In November, however, imports declined to £73,000,000 compared with £85,000,000 in the preceding month and £83,000,000 in November 1939. The export trade was sustained because of the need for foreign exchange but not at the levels of the previous year. For the first eleven months of 1940 the import surplus amounted to £617,000,000 compared to £359,000,000 in the same period of 1939.

The diversion of so much productive activity to war needs naturally had its financial repercussions. Fifty per cent of the total national income was absorbed in war expenditures and 60 per cent in government as a whole. Part of these funds were raised by taxation. The basic rate for the income tax was increased to 42.5 per cent, the highest in its history. Sales taxes, especially on luxuries, were imposed and the excess profits tax reached 100 per cent in many cases. All businesses had to pay a National Contribution tax. As a result of these taxes, revenues will cover $5,440,000,000 of the expenditures for the fiscal year ending March 1941, leaving a deficit of $8,424,000,000.

Funds to meet the deficit were raised in part by long term bond issues. Some of these bonds yielded 2½ per cent, others 3 per cent. A special issue with attractive provisions for small borrowers carried 3.17 per cent. Further funds were obtained by taking over savings deposits directly from the banks. The government paid the banks 1½ per cent interest for the use of these funds for a year. Other funds were obtained at short term by the sale of Treasury bills. Rates on these bills declined during the year and were only 1.03 per cent in September.

The resources of the banking system were still adequate to meet the demands upon it. At the commercial banks customers' loans declined enough to make up for the increased holdings of Treasury bills. Deposits increased moderately from £2,278,000,000 in September 1939 to £2,597,000,000 in September 1940. Interest rates declined for commercial loans in the open market. At the Bank of England discounts were at low levels and holdings of securities increased but little. Note issues did expand; they were £592,000,000 in October 1940 compared to £511,000,000 in August 1939 before the outbreak of the war.

Although the changes in banking statistics did not indicate any great inflationary tendencies, prices in Great Britain rose substantially during the first year of the war. The Economists' wholesale price index (1929 = 100) rose from 75 in August 1939 to 107 in October 1940, the cost of living index increased from 95 to 117 in the same period. Price regulation had been provided under the acts of August 1939, but provision was made for changes due to cost of production. Rises in wages led to rises in costs; so did rises in railway rates. The cost-price spiral definitely appeared.

In spite of the rising prices, control of the foreign exchange market was increasingly effective. At first the pound sterling had been unpegged and allowed to find a new level. In March the new official rate was established at $4.035. To maintain this rate the stabilization fund from time to time called in from citizens their holdings of specified lists of securities compensating them with British government bonds. The sale of these securities became an important factor in the New York market when the proceeds were held. The free market for Sterling was gradually restricted. A method of evading the laws prohibiting the withdrawal of capital had been to have foreign subsidiaries of British corporations withdraw funds from the parent company. This practice was finally forbidden in the fall. At the same time, Great Britain entered into agreements with the United States and other American countries providing for clearing arrangements and even, finally, for 'blocked' sterling. As a result the free rate came to coincide practically with the official rate.

In its mobilization of resources, Great Britain attempted to include the whole Empire. In the fall, a conference was held at Delhi to provide a coordinated plan. Production was planned in such a way as to relieve Great Britain of the necessity of sending goods, thus freeing more ships. Such plans, including as they did the building of new factories, were of a long range nature. They will press the industrialization of the Eastern Empire. Not only was production planned but so also was the army and navy necessary for the protection of India and Australia and New Zealand. Thus the burden of defense was shifted from England. The amount of funds for which the Empire could be called upon was also considered. Australia and New Zealand were thought to be in a position to make sacrifices equal to those of Great Britain herself, that is of some 50 per cent of their national income. Their population is not large, however, and thus the contribution would be relatively small. India, with its large population, lives so close to the minimum standard of living that it has little surplus to contribute.

Continental Europe.

On the continent of Europe, the breakdown of France had the most serious economic consequences. In the early months of the year, the course of events had been similar to those in Great Britain. Government regulation of the economic life of the nation had been even more strict, perhaps. Taxes were very heavy. The hours of labor were increased for ordinary businesses and in defense industries could be 72. Wages were fixed at ordinary rates for overtime. All of this was in marked contrast to the conditions of but a few years ago when the Popular Front was in power and very different from conditions in 1914. Price fixing was strict. Of the effectiveness of these controls little evidence is available. Price and production indexes were discontinued. Bank statistics suggest that mild inflation was in progress. Note circulation of the Bank of France increased continuously though gradually. Discounts and deposits of the commercial banks followed a similar course. The value of the franc in the foreign exchange market sagged, reaching 1.85 cents in May. All of the changes were accelerated just before the capitulation came, and with it came a complete disruption of economic life when France was divided into the occupied and unoccupied territories.

In Germany itself, meantime, the pace of financial deterioration of last year continued but was not accelerated appreciably. Note circulation of the Reichsbank which had been 8,989,000,000 reichsmarks before the war rose to 12,937,000,000 of reichsmarks on Oct. 31, 1940. Holdings of Treasury bills by the Reichsbank increased in similar proportion. The index of whole-sale prices rose from 107 (1913 = 100) in October 1939 to 111 in October 1940. Retail prices increased from 122 (1913-14 = 100) in October 1939 to 133 in August 1940. As explained above, rationing in Germany was much more complete and effective than in Great Britain. No data on production or trade is available. Labor shortages were reported and the periods of forced labor in the labor camps was increased. Bombing took its toll on production in Germany, also, but there is no way of discovering how seriously.

As Germany occupied one country after another in western Europe, the financial and productive activities of these countries had to be consolidated with those of the Reich. In each case the plan appears to have been to draw as much in raw materials from these countries as was possible. Manufacturing was not extensively encouraged even for war purposes. In northern France, as the armies retreated the factories were dismantled and machinery was carried behind the lines. Later when this equipment fell into German hands the factories were not reopened. Coal mines in the north were reopened, however, and served to supply German needs. In the reconstructed Europe the evidence seems to point to the concentration of industrial activity in Germany, while other countries are reduced to a dependent position of suppliers of materials. This plan applies to Poland, Norway, Belgium and Holland as well as France.

In each of these countries certain similarities of tactics appeared. From most of them a labor force was moved into Germany to help with the harvest and with other work when there was a shortage of labor. One hundred thousand Dutch were moved in this manner in October, and earlier there were similar transfers from Norway and from Poland. Besides, there were transplantings of whole populations where such a movement seemed desirable, from Lorraine to unoccupied France for instance, when the number of unemployed in Lorraine became too great. Such movements tended to disrupt the labor force at home and to break up national spirit.

Another feature of the occupation was the heavy purchases of products from each country. In 1914 products were simply taken. This time the arrangements were more elaborate. The Germans bought such goods as they wished at prevailing prices in the domestic currency. This process served to allay the antagonism of the population. The funds used in payment were required to be furnished by the Central Bank of the country, which in turn issued bank notes. The German Government then reimbursed the Central Bank with marks or mark assets. But at the same time they charged the country for the expenses of occupation sums sufficient to cover all these assets so that they had to be transferred to Germany again. In fact, the sums were so large that for France alone they exceeded the reparation payments of the last war at their maximum. Although the process was sufficiently complicated so that the ordinary person in those countries failed to grasp its significance, the ultimate result was that Germany acquired goods from the conquered territories while those territories experienced shortages of goods. These shortages were aggravated by the fact that during the acute stages of conflict and for many months afterwards production was severely reduced. Men were called into the army, factories were dismantled or destroyed, transportation broke down. The British blockade cut off the usual sources of materials and closed the customary markets. Crops were destroyed or remained unharvested in the fields. Thus when materials were scarce, the new demands were disastrous. Prices, in the absence of price fixing, rose quickly. In Denmark, for instance, the wholesale price index (1929 = 100) rose from 103 in September 1939 to 169 in October 1940. By winter a serious shortage of food threatened in many places.

Such were the effects of direct invasion. Other countries on the continent were little better off. Italy was already depleted by the Ethiopian war when this war began. Official data on conditions is lacking as in so many other countries. Unofficial sources reported that all imports of coffee, meats, rubber and jute had ceased while imports of oils, fats, cereals, raw cotton, wool and hides had dropped to a small fraction of their former levels. Food prices, already high in 1939, rose 33 per cent after the war began. The rationing of food was very strict and five meatless days a week were required.

Neutral Countries.

In neutral countries declining trade and rising prices were the rule. In Sweden the production index (1929 = 100) dropped from 158 in August 1939 to 133 in August 1940, imports declined from 217,000,000 krone to 123,000,000 krone and exports from 184,000,000 krone to 97,000,000 krone. Meantime, wholesale prices rose from 111 (1935 = 100) in September 1939 to 146 in October 1936. For Switzerland, the situation was similar. Imports and exports declined rapidly and the wholesale price index (1929 = 100) rose from 83 in September 1939 to 108 in September 1940. Both these countries were practically compelled to carry on trade with Germany. Such trading was done under clearing arrangements. In October, a new agreement was negotiated between Switzerland and Germany as the result of which Swiss balances accumulated in Berlin and could not be removed. In a similar way all trade between occupied countries was cleared through Berlin and led to accumulations of credits there. Thus Germany was able to make use of these balances for financing war production while the countries that owned them suffered shortages of goods and, in most cases, inflation.

United States.

In the United States, the transition to production on a war basis came more slowly than was anticipated at first. At the outbreak of war prices of strategic commodities had increased spectacularly. The Bureau of Labor Statistics index of wholesale prices rose 5 per cent in a month and the Annalist's Sensitive price index by 33 per cent. This rapid rise in prices came from a speculative demand for commodities. It was followed by increased production in anticipation of war needs. At its high point in December, the Federal Reserve Board index of industrial production (1935-39 average = 100) was 126. But the war demands did not develop as expected and prices and productive activity declined again in the early months of 1940. The index for production was only 111 in April. The production of durable goods declined even more; the index for December had been 140 but was 113 in April. The wholesale price index meantime dropped from 79.4 (1926 = 100, Bureau of Labor Statistics) to 78.6 in April and continued to decline until it reached 77.4 in August.

When the war became more intense and the threat to American security grew the demand for war materials materialized and with it came the beginnings of an industrial boom. The index of production in general increased slowly at first and then rapidly until it was 128 in October, while that for durable goods reached 151 at the same time. With this increase in production went the normal accompaniments of a boom. The index of employment (1923-25 = 100) rose from 100 in June to 108 in October and that for payrolls from 98 to 114. The wholesale price index increased also under the combined stimulus of war demands and increased payrolls until it was 79.8 in the first week of December. Certain products, notably lumber, increased in price by as much as 20 per cent during the fall.

The increases in prices which occurred in the fall of 1940 were a much more serious matter than those that occurred in 1939. In 1940 price increases came from the increase in demand for goods for the real needs of the defense program and of consumers, those of 1939 from a demand for goods to hold in stock. The demand of 1939 was, therefore, temporary, that of 1940 was a continuing one. It was a serious matter because inflation has always accompanied wars in the past and the banking system of the United States was in a condition to provide the basis of inflation without serious check.

The extreme liquidity of the banking system was a direct result of the heavy imports of gold to this country at a time when the demands of business were not great. The imports in 1939 had seemed very large but those of 1940 were even larger. By the end of the year the United States held 80 per cent of the total gold supply of the world and amounted to $21,755,000,000. This gold supply allowed a reserve of 90 per cent against the liabilities of the Federal Reserve System, a figure more than double the legal requirements. The member banks of the Federal Reserve System had $6,800,000,000 of excess reserves by October.

There was also evidence that the demand for credit from the banks would develop. The amounts of money appropriated for the national defense program were on the levels of the peak of war demand in 1917. During the summer, Congress appropriated some $6,500,000,000 to be spent before June 1941. In the later months of 1940 Government expenditures were at the rate of some $750,000,000 to $880,000,000 a month. In no month did revenues provide for this expenditure and in one month the deficit was $803,000,000. At the end of October the gross debt of the United States Government was $44,137,000,000 and $5,810,000,000 of fully guaranteed obligations were outstanding also.

This deficit drew upon the funds of the banks in two ways. In the first place the member banks of the Federal Reserve System increased their holdings of securities during the year, thus providing funds for orders for armaments. In the second place, because of these demands the firms receiving orders turned to the banks for funds to supply their needs in constructing new plants and in increasing their production. At the end of the year commercial loans were increasing.

Because of the danger of inflation through the expansion of bank credit the Board of Governors of the Federal Reserve System applied to Congress for new powers to control the credit supply. The powers which they needed were primarily those of increasing reserve requirements and of limiting holdings of Government bonds. Also they wished to have revoked the powers of the Treasury and the President over the issue of paper currency and the value of the gold content of the dollar. This program was presented to Congress at the beginning of January 1941.

The increase in production of goods was accompanied by increases in exports in spite of the difficulties of shipping and the closing of continental markets through the British blockade. The value of these exports was surprisingly constant at a level of about $350,000,000 a month. The increase in exports to Great Britain was sufficiently large to counterbalance declines in exports to other parts of the world. The volume of imports was also well sustained. Here increases in trade with South America, Canada and Asia, other than Japan counterbalanced losses from Continental Europe. Thus, although the direction of foreign trade changed, its volume was not significantly disturbed.

Canada.

In Canada economic conditions followed a pattern similar to those of the United States. Business slumped in the beginning of the year and expanded again later. The index of industrial production (1926 = 100) dropped from 138 in December 1939 to 127 in March 1940 then rose to 153 in August. Price changes were even less than in the United States. The wholesale price index (1926 = 100) rose from 82 in December 1939 to 83 in September 1940. The cost of living index (1935-39 = 100) rose from 103.8 to 106.4 in the same period. The foreign exchange value of the currency did not remain stable. At the end of December, it had been 87.62 cents per dollar and in March it was 82.88 cents per dollar. At this time England established an official rate for the pound sterling and Canada did the same for her dollar. The rate chosen was 90.91 cents, a figure well above that of the free market. In the free market itself the rate subsequently rose but was still 86.32 cents at the end of October.

Latin America.

The South American countries were not as prosperous as their North American neighbors. The loss of their trade with Continental Europe was not as easily compensated. In Argentina for instance, although the export trade was only 3 per cent below that of the previous year in the first ten months in value, it was 21 per cent below in physical volume. In October even in value it was 45 per cent below last year's level. Exports of grain and fruits declined but that of meat increased. The production of petroleum increased 20 per cent in the first eight months of the year. In spite of these favorable factors the depression in the Argentine was severe. The grain markets were badly affected. At the end of 1939, grain prices had been high and the government ceased fixing minima for many products. In the fall of 1940 price fixing had to be reintroduced. The government was authorized to take over the entire wheat crop of 1940-41 at 54.7 cents a bushel. To alleviate distress among the industrial unemployed, the government introduced plans for new low cost housing projects.

Brazil similarly encountered difficulties of adjustment to the war basis. Exports of raw cotton declined to nearly half of what they had been a year before. The coffee market was unsettled. In the fall, however, the 14 coffee-producing States entered into an agreement establishing quotas for their exports to the United States. The new plan had a stabilizing effect on prices. A trade agreement with Argentina was negotiated.

The other raw material producing countries met the same problems. Cuban trade was dependent on its sales of sugar, and the sugar market was disrupted; Peru suffered from this same cause and also from the impossibility of selling its cotton. Chile, however, experienced much less trouble. Productive activity was well sustained and its foreign trade even increased.

The effect of the declines in trade showed themselves in the foreign exchange markets. In several of the smaller countries the exchange rates broke in spite of the official exchange controls; in Argentina, Brazil and Chile, they remained stable though imports had to be restricted. The United States made special efforts to help these countries stabilize their currencies. The Export-Import Bank made loans of two categories, first, to stabilize currencies directly, second, to organize and equip new industries. Stabilizing loans were made to Argentina, Brazil, Colombia, Peru and Costa Rica; Industrial loans were made to Brazil for a steel plant and for an electric railway, to Chile for a hydroelectric plant and others to Nicaragua, Costa Rica, Panama, and to Paraguay to build roads. The amount of money involved in these loans was $650,000,000.

These loans by the Export-Import Bank provided financial relief to South America for relatively short periods. To provide more adequately for the future, a convention was drafted by delegates from the United States and the South American countries providing for the Inter-American Bank. This bank, to be capitalized at $100,000,000, will have broad powers to make long and short term loans, and to engage in any other financial activity which will be mutually beneficial to the trade of the countries involved. At the end of the year the Congress of the United States had not ratified the convention nor granted the charter though enough States had ratified to bring the Bank into being. (See also PAN-AMERICAN COOPERATION.)

The Orient.

In the Orient war conditions continued to produce economic deterioration. In Japan, in the first nine months, trade was on a higher level than last year, but in the autumn it declined. Japan, therefore, decided to discontinue trade statistics. A shortage of water in November led to a shortage of electricity which affected production seriously. The rice crop was the smallest in five years and exports of cotton cloth were 20 per cent less than last year. State controls over banking and business were extended and in shipping the Communications minister announced that there was to be a 'liquidation of liberalism.' Financial conditions remained relatively stable. Note circulation of the Bank of Japan expanded by nearly 30 per cent but prices rose by only 5 per cent. The gold reserves of the Bank remained as large as last year and the foreign exchange value of the yen was unchanged.

In China, conditions changed rapidly for the worse in 1940. Imports increased in value at a very rapid rate, partly in response to price changes, while exports remained at low levels. The consequence was an ever increasing pressure on the exchange market. The situation was aggravated by the unbalanced budget of the government. Funds were raised to a large extent from the commercial banks which covered the advances by increasing their note issues. Prices rose very rapidly. Wholesale prices at Shanghai, for instance, rose from 253 in August 1939 (1929 = 100) to 486 in August 1940. The yuan dropped in value from 7.49 cents in December 1939 to 5.08 cents in May 1940 and was 5.68 cents in October. These quotations conceal to some extent the real seriousness of the situation, for loans from the United States helped to support the market. The Export-Import Bank made one such loan in the spring and two in the fall totalling altogether $95,000,000. See also articles on the various countries involved and on BUSINESS; EUROPEAN WAR; INTERNATIONAL CONFERENCES; INTERNATIONAL LAW.