The War Crisis.
During 1939 the dominant factor underlying world economic conditions was the increasing political tension among the great powers which culminated in the outbreak of actual war in Europe in September. In the United States the tension caused a turning of economic activity into those channels which provide materials of war. Abroad, countries sought to secure sources of the raw materials of war or sufficient accumulations of foreign exchange to purchase such materials. To accomplish these objects, governments everywhere increased their expenditures, and the burden of indebtedness rose rapidly. The increases in government demands for goods and the creation of credit for their purchase led to increases of productive activity and decreases in unemployment. Financial structures in Europe began to show signs of strain before the end of 1939 though in the United States funds were still abundant. To protect themselves from the effects of inflation and to provide greater efficiency, governments assumed continually greater controls over economic enterprise. After war broke out in the belligerent countries only the barest remnant of free enterprise remained. In the Orient, the strains of war presented themselves in their more advanced stages. In spite of controls inflation was evident. South American economic life was disturbed but little and the year brought greater currency stability partly because of demands for raw materials from Europe. Throughout the year the struggle for markets led to methods of competition which tended to break down normal trade among nations, while the outbreak of war itself, with the embargoes and restrictions which accompanied it, almost completely severed such intercourse in many parts of the world. Neutral countries, particularly the American Commonwealths, attempted to strengthen commercial ties among themselves.
Expenditures for National Defense.
Economic conditions in the first nine months of 1939 in most European countries were centered about the problem of providing rapidly for greatly increased means of national defense. Even at the beginning of the year it was doubtful whether the Munich agreement would prevent war. The seizure of the remnants of Czechoslovakia, in April, dissolved what doubts remained and all energies were bent towards preparedness. The procuring of armaments on so large a scale entailed heavy government expenditures financed by borrowing. Thus even before war broke out the initial steps for large scale diversion of resources from private uses had been taken.
General.
In Great Britain expenditures for national defense in the fiscal year 1938-39 amounted to £400,000,000. In April the first budget estimate for 1939-40 was £580,000,000 but the figure was raised almost immediately to £630,000,000 and in July to £730,000,000. Even on the basis of £630,000,000 these expenditures would have been 43 per cent of total Government expenditures and 12 per cent of the total national income. The Government expected to raise fully £500,000,000 by borrowing. For France, the budget carried expenditures for the year 1939-40 of 40,885,000,000 francs, an amount equal to 49 per cent of all government expenditures and 18 per cent of the total national income. From January to June 1939, 23,000,000,000 francs had been borrowed and the national debt stood at 444,000,000,000 francs. For Germany, the Government budget is not made public. That expenditures for armaments are relatively high compared to France and England can be judged only from changes in the type of productive activity and in the government debt. At the end of March 1939 the funded debt of Germany amounted to 24,208,000,000 reichsmarks and the floating debt to 6,535,000,000 reichsmarks giving a total of 30,743,000,000 reichsmarks. At the end of March 1933 it had been 11,690,000,000 reichsmarks. Meantime, currency circulation has increased from 5,656,000,000 reichsmarks to 10,388,000,000 reichsmarks. Moreover, tax and customs receipts rose from 6,600,000,000 reichsmarks to 17,700,000,000 reichsmarks. Such a debt could only arise from tremendous expenditures on arms. Other countries of Europe also had heavy expenditures. The Union of Soviet Socialist Republics, for instance, provided for 40,885,000,000 rubles in their budget this year and Sweden, 272,000,000 krona. Even in the United States the need for means of defense became so evident that the budget for 1939-40 carried appropriations of $1,320,000,000, the largest amount for any peace time year.
Great Britain.
With expenditures of such magnitudes the financial structures of the various countries could not but be affected. At the Bank of England note circulation began to expand rapidly to meet the demands for payrolls. On Jan. 25, 1939, it had been £464,000,000 and on July 26 it was £511,000,000. Gold reserves underwent a series of changes tending to strengthen the Exchange Equalization Account. On Jan. 6, £200,000,000 was transferred to the Account from the Bank. On March 1, the gold stock of the Bank was revalued at current prices instead of legal parity and £5,500,000 were transferred back from the Account and on July 12 another £20,000,000 was added. As a result of these transactions the Bank had £279,000,000 when war broke out. In the banking department of the Bank discounts and advances declined and investments rose. At the clearing banks holdings of securities declined while loans and discounts dropped for the first three months of the year and then advanced steadily. Money rates in the market were low at the beginning of the year at .55 per cent for bankers' acceptances and .50 per cent for Treasury bills. At the time of the crisis in April, they jumped to 1.40 per cent and 1.36 per cent respectively. Thereafter, they did not return to their former low levels but were .79 per cent and .77 per cent in July. Security prices dropped during the early months of the year, stiffened after the crisis but declined again as tension increased in August. The price of consols declined continuously with yields of 3.46 per cent in January and 3.96 per cent in July. New capital issues exclusive of Government issues declined in volume. Wholesale commodity prices were practically stationary with an index (1930 = 100) of 97 in January and 98 in August.
France.
In France, financial changes progressed more rapidly. Note circulation of the Bank of France rose from 109,378,000,000 francs in January to 123,239,000,000 francs in July. Gold holdings were strengthened by transfers of 5,000,000,000 francs on April 20 and again on Aug. 3. Deposits declined during the April crisis but rose again thereafter. Advances to the Government and bills discounted showed no marked trends. At commercial banks bills increased steadily, while deposits rose until May, but declined somewhat in June and July. Money rates in the open market were much lower than in 1938 at 1.94 per cent in January and 1.88 per cent in July. Security prices moved erratically but remained well above their level in 1938. New capital issues were a little higher than in the previous year. Commodity prices declined from an index of 689 (1913 = 100) in January to 674 in August.
Germany.
In Germany, the note issues of the Reichsbank expanded more rapidly than note issues in either France or England. At the end of January, they were 7,816,000,000 reichsmarks and on July 31 they were 8,989,000,000 reichsmarks. Since reserves remained practically constant, the increases were covered by increased holdings of securities, and holdings of Treasury bills expanded also. Commercial bank discounts increased steadily as did deposits. Money rates declined from 2.88 per cent in January to 2.75 per cent in July. Security prices declined and new capital issues remained at last year's levels.
Other Countries.
In the countries that were later neutral similar tendencies were visible. Everywhere note issues expanded and bank deposits tended to rise. Interest rates varied from country to country. In Sweden and Italy, rates were constant at 2.50 per cent and 5.25 per cent respectively. Holland and Belgium both suffered severely at the time of the crisis in April. In Belgium, the open market rate rose from 1.98 per cent in February to 4.28 per cent in April, and in Holland, from .19 per cent to 1.28 per cent. Later those rates declined again. In the United States note issues expanded from $6,839,000,000 in January to $7,902,000,000 in July; gold reserves (see below) increased from $14,565,000,000 to $16,227,000,000. Commercial bank deposits rose from $21,231,000,000 to $22,705,000,000. Interest rates remained at low levels throughout the period except for a slight tightening of rates on Treasury issues at the crisis. Security prices declined in the early months of the year and dropped precipitously at the crisis. During the remainder of the period they rose again slowly. New capital issues were in small volume except for Federal Government issues.
Industrial Comparisons.
Great Britain.
The effects of the preparations for war showed themselves also in productive activity. In Great Britain, the general index of production (1930 = 100) which stood at 126 in December 1938 rose to 133 in June 1939. For many lines of goods which are closely associated with defense, production was practically at capacity in June. Thus the steel industry was near its effective capacity of 14,700,000 tons per annum and the engineering industry was having to lengthen delivery dates. A shortage of labor was developing in this industry and in the wool trade it became necessary to hold up civil orders. The coal industry could still expand but it was doubtful that there would be any export surplus in the winter when seasonal demands became high. Although wage rates, and hence costs, had not yet risen, total payments to labor increased because of increased employment, the index for which (1935 = 100) rose from 110 in January to 115 in June. The increase in purchasing power increased demands for consumption goods, so that production in these lines, too, was heavy.
France.
In France, similar tendencies existed. The general index of production (1928 = 100) increased from 86 at the end of December 1938 to 100 in June 1939. War industries again were most favored but other industries such as the export industries and automobile production received benefits. The low level of French prices compared to world prices was a factor in stimulating non-war demand. Unemployment decreased and a shortage of skilled workers developed. It is difficult to trace the extent of stimulation of the consumption goods industries in general but in the building industry expansion was marked.
Germany.
In Germany, productive activity had reached a high level last year but the general index (1929 = 100) rose further from 129 in December 1938 to 135 in July 1939. Here the labor shortage was sufficient to prevent the continued expansion of both armaments and consumption goods and consumption goods were sacrificed. The index for investment goods (chiefly armaments) increased from 131 in January to 147 in July, while that for consumption goods dropped from 124 to 117 in June but rose to 120 in July. Thus in spite of the rigid control of prices the population must be suffering from decreases in actual standard of living.
Other Countries.
In other European countries productive activity followed a similar course. The general index (1929 = 100) rose from January to June, for Belgium, from 74 to 81; for Denmark, from 138 to 146; for Norway, from 125 to 139; for Poland, from 118 to 127; for Sweden, from 147 to 156. In America, the situation was somewhat different. In Canada, production followed the same course as abroad with an index which increased from 90 to 98. In the United States, the production index dropped from 86 in January to 77 in May. Only in summer did activity begin to advance. To be sure, war orders from abroad did not affect American markets until summer and the domestic armament program was later in getting under way but expenditures for relief had remained high. The number of unemployed remained alarmingly large.
Trade Comparisons.
Foreign trade, like production, tended to increase. Imports were necessary to build up stocks of goods against the time of war while exports were necessary to supply exchange. For Great Britain, the index of imports (1935 = 100) for the first two quarters of the year were 108 and 113 respectively compared to 111 and 104 last year and for exports 102 and 101 compared to 100 and 94. For France, imports amounted to 24,766,000,000 francs compared with 23,264,000,000 francs last year while exports were 18,040,000,000 francs compared to 13,964,000,000 francs a year before. For Germany (including Austria) on the other hand trade declined, for imports from 2,883,000,000 reichsmarks to 2,734,000,000 reichsmarks and exports from 2,796,000,000 reichsmarks to 2,793,000,000 reichsmarks, leaving an adverse balance of trade. For the United States, the export trade declined while the import trade increased, but an excess of exports of some $50,000,000 a month still continued.
Gold Movements.
Partly because of the balance of trade but chiefly because of the political tension, gold was exported to the United States in amounts even greater than during 1938. In April alone $606,000,000 net were imported and in the months from then until October the figure never fell below $250,000,000 a month. By far the larger portion of this gold came from the United Kingdom, but substantial amounts were sent from Belgium, the Netherlands, Switzerland and Canada. Almost none came from France. In fact throughout the first seven months of 1939 France gained gold in considerable quantities. The quantities of gold exported from the United Kingdom and Canada are partly fictitious. These countries were simply intermediaries between continental countries and the United States. Of the gold exported from England, a large portion had come in turn from Belgium, the Netherlands, Switzerland, and the British Dominions, while most of the gold from Canada came originally from England. In spite of the magnitude of these movements exchange rates remained stable chiefly because of the support of Exchange Equalization Funds.
Aspects of the War Crisis.
As the necessity for mobilizing national resources became more apparent and as mounting public debts began to suggest the possibility of inflation, governments assumed more and more control of economic organization.
Germany.
In Germany the powers of the Government were already tremendous, but they were further increased this year. Dr. Schacht, who had accomplished so much for the Reich financially but who stood firmly against inflation, was relieved of the presidency of the Reichsbank and replaced by Dr. Funk, Minister of Economics, who was willing to assure conformity of financial policy to general governmental policies at all costs. He immediately issued new currency in the form of tax certificates which Government agencies were allowed to use in payment of 40 per cent of their purchases. Recipients of these certificates were allowed to use them again for 40 per cent of their costs. The certificates carried a reduction in taxes if they were used in their payment after from six to eighteen months. Thus the Government began to anticipate its income and the straight road to inflation was opened. A billion marks of this kind were issued by June. That the danger of inflation was a very real one was shown by the new decrees regulating prices which were issued in April. Prices had been controlled for some time but the new orders were much more stringent. The low of October 1936 had provided for rises in prices only when changes in costs justified them; under the new plan, the Price Commissioner was given dictatorial powers. Industries might include in costs only standard wage payments fixed by the commissioner. Thus the commissioner by properly fixing costs and final prices might render unprofitable any industry which was unwanted. This decree completes the breakdown of the principle of price as an adjuster of demand and supply. A further step in government control was the consolidation of the Reichsbank in the Government. Shareholders were forced to transfer their stock into other securities. German citizens had to accept Government bonds but foreign stockholders received shares in the Gold Discount Bank. For foreigners this meant little economic loss but to the Reichsbank it meant complete freedom from outside controls. Immediately thereafter the Bank ceased publishing figures for the gold reserve and the note circulation was freed from even nominal limitation.
France.
In France, the loss of economic freedom began seriously only in November 1938 and was by no means in the same category with Germany. Although the Government issued decrees concerning economic matters these decrees had as their purpose primarily the restoration of monetary stability within a framework of monetary freedom. With regard to labor, the November decrees allowed greater conformity to freedom of contract. In March and April, a new series of decrees brought a definite movement towards a controlled war economy. The decrees were directed towards three ends: an effective distribution of the labor force, a limitation upon consumption, and a limitation upon the creation of money. Employers' freedom of engagement was limited so as to direct labor towards industries important for defense; the normal week was increased to 45 hours with possibility of a 60 hour week, compensated by overtime pay. In defense industries, taxes were increased. State orders were given priority over private orders with all manufacturers, and industries working on State contracts were forbidden to compete for labor. The central wheat office was reorganized and an attempt was made to induce people to return to the land.
Great Britain.
In Great Britain, too, the Government began to take steps early in the spring to mold the economy to war needs. To some extent this was accomplished by means of subsidies. Shipping subsidies helped to foster a merchant marine and subsidies for increasing acreage under cultivation, for building up reserves of fertilizers, seeds, farm machinery, and so forth, provided for increased agricultural production. In April, the formation of a Ministry of Supply was announced. Its powers were to include the right to secure priority of Government orders, the right to require business firms to produce for the State and even to alter their plant to do so. Companies' books were made subject to government inspection to determine fair prices. This program was not put into effect immediately; the ministry announced that compulsion would not be used as long as there was sufficient voluntary compliance.
International Trade.
In the field of international trade, governments continued to foster exports artificially, Germany extended the use of Aski marks and of clearing agreements. In April, added financial facilities were given to German exporters. The Reichsbank gave reduced discount rates and longer currency for export bills; new methods of insuring against exchange risks were provided and the German stamp duty on bills drawn in foreign currencies was suppressed. To protect itself against subsidized goods, the United States imposed a 25 per cent duty on dutiable goods imported from Germany, and in July imposed a similar duty on Italian goods. To meet the competition for foreign markets both Great Britain and the United States resorted to subsidizing trade. In both countries, quasi-government banks existed to make loans for foreign trade. In 1939, the funds available for these institutions were increased and their business was extended. The Export Credit Guarantee Department of the United Kingdom made loans to New Zealand to finance imports from Great Britain and to the Chinese government to help stabilize its currency. The Export-Import Bank of the United States made loans to finance imports from the United States to Paraguay, Poland, Portugal, the Argentine, China, Brazil and Finland. The United States Treasury made a direct loan to Brazil to stabilize its currency and it added this year a direct subsidy on the export of cotton. France made a beginning in this field with a large loan to Poland for electrification schemes to be repaid through additional Polish exports to France and liberalized the terms of her clearing agreements with Rumania and Jugoslavia. Finally, the governments of the United States and Great Britain resorted to direct barter of stocks of surplus commodities, exchanging 600,000 bales of cotton for 80,000 tons of rubber. It was understood that these commodities would be used for emergency war stocks only. All of these schemes show the increasing difficulties of carrying on foreign trade when markets tend to be monopolized by nations having clearing agreements and the lengths to which such competition drives the exporting nations.
Such were economic conditions in the western world when war actually broke out. The war itself served to complete the difficulties of world trade. The danger to commerce all over the world and, of course, especially in the North and Baltic seas virtually closed many countries to trade, and embargoes intensified the difficulties. Embargoes were placed not only by belligerents against each other but by governments on their citizens to prevent the loss of essential products. The conduct of the war proved to be peculiar. The expected air attacks did not take place, and real warfare on the western front had not developed at the end of the year. Hence the demand for explosives and ammunition was much less than expected, while that for aircraft and shipping much larger.
Government-controlled War Economies.
The first effect of war in the belligerent countries was the extension of controls over the economic life of the countries so that little freedom existed. In Germany, control had been so complete before the war that little extension was necessary. In Great Britain, measures had been prepared and their application took place almost at once. First to be enforced were financial restrictions. The Exchange Equalization Account ceased selling gold and all the gold reserve of the Bank of England was transferred to the Account. At the same time, the fiduciary issue of the bank was raised to £580,000,000. Foreign exchange could be obtained only through the Bank of England. Although the acceptance houses and merchant bankers, the usual channels for supplying exchange, still had direct access to the bank, the Clearing Banks were designated as official agents. All residents of Great Britain, whether citizens or not, were required to register their holdings of foreign exchange and of foreign securities. Thereafter, they could transfer these assets to other residents of Great Britain under license but not to outsiders except under the most exceptional circumstances. In this manner, the export of capital was prevented. The security markets also came under close supervision. Minimum prices were fixed for all securities. The price chosen was that at the close of the market on Aug. 23. Trading for the Account was discontinued for the duration of the war. New capital issues could be floated only subject to regulation. Thus was financial control shifted to the Exchequer. It is doubtful whether the London market can ever return to its former organization. The merchant bankers and acceptance houses are losing their business in exchange and in securities. Besides, they were heavily loaded with acceptance credits, for instance under the Standstill agreements with Germany, which probably never will be repaid. Although the Bank of England offered temporary loans against such collateral at a penalty rate of 6 per cent ultimate losses will fall on the private bankers.
Control was not confined to finance. The Ministry of Supply began to assume its full functions. All essential supplies had to be ordered and distributed under its supervision. Commodity prices were fixed at the level prevailing on August first subject to certain adjustments for changes in costs, upon approval of the Government. The Government undertook to regulate transportation and shipping. Thus, of the old order of free enterprise very little remained.
In France, similar conditions prevailed. The Bank of France took over the regulation of foreign exchange and security issues. Commodity prices were fixed at September levels. Limits were set to increases in wages and profits. Embargoes were placed on the export of essential products. Taxes were increased. Government by decree was extended. Even in the United States the Government increased its power. At first, an embargo was placed on all exports of arms and implements of war. Later, this Embargo Act was repealed but American ships were forbidden to enter the combat areas and sales to belligerent countries were allowed only under the 'cash and carry' system. Moreover, the President declared that a situation of limited emergency existed, thus conferring unusual powers upon the chief executive.
Great Britain.
Along with the breakdown of economic freedom went extensions of the economic tendencies which developed during this period of increasing tension. In Great Britain, the immediate effect of the outbreak of war was a tightening of money rates of even greater magnitude than had occurred in April. The Bank rate was raised to 4 per cent on Aug. 26. Open market rates rose in sympathy. Bankers' Acceptances had been discounted at .79 per cent in July but in September the rate averaged 3.51 per cent. Rates on Treasury bills rose from .77 per cent to 3.23 per cent and day-to-day from .77 per cent to 2.72 per cent. These rates were not maintained for a long period. On Sept. 28, bank rates dropped to 3 per cent and on Oct. 26 to 2 per cent. The rate on Bankers' Acceptances was 1.88 per cent, at the end of October, that for Treasury bills 1.77 per cent, and day-to-day money 1.71 per cent. Although these rates were not as low as those prevailing in the spring, they were exceedingly low for a war period. Meantime, the debt of the government mounted. The floating debt had been £1,138,000,000 on Aug. 26; it became £1,311,000,000 on Oct. 28. Note issues of the Bank of England expanded. At the end of July, they had amounted to £510,000,000, at the end of September to £542,000,000, but at the beginning of November they had declined again to £527,000,000. Wholesale prices of foods in spite of the controls, rose from an index of 90 (1930 = 100) in August to 109 in October. Prices of industrial products rose from 102 in August to 107 in September (the October figure is not yet available). Cost of living (1914 = 100) jumped similarly from 155 in August to 165 in October. No index for production for the period after the beginning of the war is available. That productive activity was seriously dislocated is evident from the unemployment figures. Between Aug. 14 and Sept. 11, the number of unemployed increased by 98,000, and between Sept. 11 and Oct. 16, by another 101,000, in spite of the fact that large numbers of men previously employed were called to the colors. The decreases in employment came primarily in the luxury trades and were chiefly among women. Increases came in such industries as the metal trades, textiles, coal mining, tailoring, dress-making, and fishing. Foreign trade was very seriously curtailed. Imports in September were 33 per cent lower than in September 1938, while exports declined by 41 per cent. The foreign exchange rate was allowed to decline with only enough support from the Exchange Control to maintain an orderly market. Before war broke out, it had been $4.68. In the last week of September, it was $3.75. Thereafter it rallied somewhat, but by the first week in December it was $3.88.
France.
In France, the favorable condition of the money market made it unnecessary to raise the discount rate of the Bank of France when war broke out. However, the private discount rate did rise from 1.95 per cent in August to 2.70 per cent in September. At the Bank of France, Government borrowing showed its effects. Direct advances to the Government rose from 20,577,000,000 francs at the end of August to 25,473,000,000 francs at the end of October. The Bank's holdings of commercial bills also increased. 'Other' domestic bills which were 5,000,000,000 francs at the end of July rose to 15,009,000,000 francs at the end of August, and 14,830,000,000 francs at the end of September. After the initial disruption of the markets passed the amount of these discounts returned to 8,298,000,000 francs. The note circulation increased from 123,239,000,000 francs at the end of July to 144,379,000,000 francs at the end of October. Deposits of both the Government and private individuals declined. Figures for production and trade since the war are not available. Shortages of labor in many fields were reported, however. The proportion of men called to the colors was much higher than in Great Britain and the relative number of unemployed was smaller. In the foreign exchange market, the franc weakened progressively as did the pound. Early in December, it was 2.22 cents.
Germany.
In Germany, the outbreak of war caused little disturbance since the country was already on a war footing. Neither the Reichsbank rate nor private interest rates changed. Note issues of the Reichsbank rose at the end of August from 8,989,000,000 to 10,907,000,000 reichsmarks, but declined a little in October. Holdings of Treasury bills and securities eligible for coverage for the note issue also increased. The new type of currency introduced in the spring proved to be a failure after war broke out and was discontinued after market value fell to 94 per cent of face value. Prices of commodities have fallen officially from 107.1 (1913 = 100) in August to 106.9. Actually there were many illicit increases in prices, a fact to which the number of fines paid by shopkeepers for raising prices gave evidence. In production, there developed an acute shortage of skilled workers. Apprentices were assigned to skilled occupations according to the importance of the industry in the prosecution of war. A decree ordered forced labor for all women between the ages of 15 and 70 years. Production of unessentials, particularly those requiring imported materials, was severely curtailed. Soap and textile manufacture were especially affected. The drive to expand exports was pressed especially upon Scandinavian countries. The reports of the German Dutch Clearing Account show that Germany has maintained her exports to Holland but that imports have decreased. A similar fall in the Clearing deficit with Switzerland is expected. This improvement in the balance of trade is undoubtedly the result of the British blockade which restricts re-exports from neutrals to Germany.
Other European Countries.
The neutral countries by no means escaped the problems of war adjustments. Sweden, for instance, is dependent on shipping for her foreign trade and was thus especially affected by the embargoes. Her trade except with Germany has decreased. Although supplies of foodstuffs were ample, other essentials were lacking. A shortage of gasoline led to a prohibition of the use of private cars. At the Bank of Sweden, gold reserves declined as well as reserves of foreign assets, while note issues rose. The exchange rate weakened progressively. In Holland and Belgium, the imminence of war made conditions even more difficult. In Holland, for instance, the private discount rate rose from .51 per cent in July to 2.94 per cent in September, while month money rose from .75 per cent to 3.66 per cent. Even in October the rates were still 1.90 per cent and 2.24 per cent respectively. In both countries, gold and foreign exchange holdings declined and note issues expanded. Foreign exchange rates weakened especially at the end of the year.
United States.
In the United States, the war produced conditions which were favorable to economic activity. It is true that the market for government securities did respond unfavorably but money rates for commercial loans in the open market remained unchanged. Issues of Federal Reserve Notes increased but little and gold reserves continued to expand. In other phases of economic life that expansion of the summer continued at an accelerated pace. Production increased at an extraordinary rate. The index of production (1923-25 = 100 adjusted) rose from 103 in August to 120 in October. The general index of wholesale prices (1926 = 100) rose from 75 in August to 79 in October, while the prices of basic commodities rose by 33 per cent. Although the prices of agricultural products were most responsive at first, later they declined again, while prices of industrial and imported basic commodities continued to rise. There developed almost a shortage of railroad facilities. In September and October, foreign trade expanded somewhat more than seasonally. Security prices, too, rose in these months. Later, however, there developed a certain hesitancy in business. Although business activity continued to expand, security prices did not continue to rise. New capital issues almost ceased except for government issues. New construction was at a low level. All of the facts support the conclusion that at this period business was very uncertain of the future course of production. The warfare was of an unexpected variety requiring much less in the way of armaments than was expected originally. Trade with many countries was cut off and the possibility of increasing trade with South America had not been fully explored. As a result, business men were unwilling to involve themselves in future commitments.
South America.
In South America, the problems of oncoming war had been more remote in the early part of the year. In the early months in some countries there was a recession similar to that in the United States. In Chile, the disastrous earthquake in January destroyed thirty cities and towns. The rebuilding of these towns was expected to take several years. In Brazil, the weakening of the currency caused advances in prices which disturbed business. In the Argentine, there was a bumper wheat crop but the corn crop was very small. Before summer, foreign trade had expanded. Exports of wheat to France and England helped the trade of the Argentine, while cotton exports from Brazil chiefly to Germany and Japan were high. The expansion of the export trade with a relatively stationary import trade in many countries caused the foreign exchanges to improve. For Brazil, the establishment of the Exchange Equalization Fund with the help of American loans in March served as a stabilizing influence. The official rate for the milreis had been allowed to drop from 8.72 cents to 5.84 cents in December 1938. In June 1939, it was raised to 6.06 cents. In the free market, the rate declined to 5.1038 cents in June and then remained relatively stable for the rest of the year. In Colombia, the exchange rate rose a little in March and remained high for the rest of the year. For Cuba and Chile, the rate was very stable. In Mexico, the rate declined in the summer after the United States Treasury reduced its buying price for foreign silver. In the Argentine, the rate remained stable until September. The outbreak of the war had at first a stimulating effect in most South American countries. The rises in agricultural prices served to alter favorably their balance of foreign trade. Retail trade at home expanded rapidly under the impetus of the new prices. However, by October, the sudden spurt in activity receded as it became evident that foreign trade would not benefit immediately by the war. Brazil was injured by her loss of German markets. Cuba had enjoyed a brief boom in sugar, while the retail demand in the United States had been high. Conditions in Mexico and Chile remained relatively stable. Argentina suffered difficulties with the exchanges induced in part by the decline of sterling. The rate dropped from 31.1 cents in August to 29.8 cents in October. In Mexico, on the other hand, the rate rose. On the whole, the final effects of war on South America could not be evaluated at the end of the year. The immediate effect was to strengthen all political relations among the several Latin American countries and with the United States. From these political relations may come strengthened commercial relations. The United States is being very cooperative in the matter of extending credits through the Export-Import Bank and in the extension of the system of reciprocal trade agreements. An agreement with Ecuador was completed this year and one with the Argentine is to be negotiated shortly.
Japan.
In the Orient, the strains of their own war were so great as to obliterate almost entirely the signs of the war in Europe. In Japan, the outstanding feature has been the increase in inflation. Note issues of the Bank of Japan reached a peak of 2,806,000,000 yen at the end of October, an increase of 624,000,000 yen in a year. The wholesale commodity price index (October 1900 = 100) rose from 255 in December 1938 to 288 in September 1939. Retail prices in Tokyo rose 13 per cent in the year. The government tried to stem the tide of rising prices by further controls and limitations upon prices and profits. A failure of the rice crop forced the government to raise its price and added further to the decline in the standard of living. Meantime, production in many lines was pushed so far that shortages of labor became apparent. Silk production was 10 per cent greater than last year. Because of the restrictions on the importation of textiles, home consumption of silk was 26 per cent greater than last year. Foreign trade this year expanded greatly. For the first ten months of the year, exports amounted to 3,071,000,000 yen, an increase of 789,000,000 yen over last year, while imports amounted to 2,566,000,000 yen, an increase of only 226,000,000 yen. The relative increase in exports relieved the strain on the foreign exchanges and allowed the Bank of Japan to keep its gold reserve intact. In the fall, the foreign exchange did break. It had been tied to sterling and when sterling declined it declined also from 27.28 cents in July to 23.51 cents in October. It was later stabilized by tieing it to the value of the dollar. Prospects of further difficulties next year arose when the United States denounced its commercial treaty in July to take effect in January 1940.
China.
In China, conditions have been even worse. Note issues of the Central Bank of China, the Bank of China and Bank of Communications, in June (only figure available this year) were 2,301,000,000 yuan compared with 1,465,000,000 yuan in June 1938. Interest rates in Shanghai rose to 6.52 per cent from 4.22 per cent in December 1938. The index of wholesale prices (1929 = 100) stood in September at 304 compared to 159 at the end of last year, and the index of the cost of living rose from 134 to 224 in the same period. A foreign trade balance did not assist the foreign exchange market. Imports this year increased very considerably over last year, while exports decreased. Both Great Britain and the United States extended loans to help stabilize the exchange rate. It is too early to judge the effectiveness of the attempts. The rate had been 15.89 cents per yuan at Shanghai in January. It declined to 6.70 cents in September, but recovered to 7.64 cents in October. See also INTERNATIONAL BANKING AND FINANCE; INTERNATIONAL CONFERENCES.
