1941: International Banking And Finance

Great Britain.

While the continuance of the war pushed expenditure, debt and taxes to new records, the efficiency of the British effort in both civilian and military directions gained from the experience of 1940; so that despite the severe air-raids of the spring, the national position was probably stronger at the beginning of 1942 than at any previous time — a result to which the manifold aid of the United States made an increasing contribution.

By the close of 1941, Government expenditure was absorbing about 75 per cent of national income according to official estimates of the latter item. The budget presented by Sir Kingsley Wood in April was accompanied by a White Paper containing an analysis of the national income — a welcome innovation; though the figure of 'net national income' for the calendar year 1940, £5,586,000,000, was somewhat lower than that shown by other reputable methods of compilation. Estimated expenditure for the fiscal year ending March 1942 was £4,206,957,000 against revenue of £1,786,360,000. These figures compare with realized total expenditure for 1940-41 of £3,884,300,000 and revenue £1,408,900,000. Actual expenditure in August 1941 was running at the rate of £12,200,000 a day, as compared with £7,400,000 in the second quarter of 1940. The total national debt, which stood at about £9,000,000,000 on March 31, 1940, rose to well over £13,000,000,000 at the close of 1941. The floating debt included in this total stood at £3,428,100,000 on Nov. 29, 1941, as compared with £2,440,500,000 on Nov. 30, 1940. A satisfactory feature of the year was the success of the 'small savings' campaign — the national effort to drain off consumer purchasing power into Savings Certificates and Defense Bonds of small denominations and attractive yields. The second accounting year of this plan, ending on Nov. 21, 1941, showed a total subscription of £633,262,731 — an increase of 30.8 per cent above the first year, and well over the 'target.' Whether the rate of subscription could be maintained, however, in view of tax changes, was somewhat doubtful.

Evidence of the extent to which British capital has been mobilized for the war effort was contained in the figures for new security issues in 1941, which stood at the record low of £2,326,000. The previous year showed new issues of £4,096,000. The scope of the restriction may be gauged from the comparable figures of £66,294,000 for 1939 and £118,098,000 for 1938. The industrial share index stood at 70.0 as 1941 began, touched 83.2 at the beginning of December, and closed the year at 79.7. The bond index started at 126.1, touched 132.5 early in December, and finished at 132. Observers discerned a noteworthy expression of confidence in these records.

The budget for 1941-42 relied for new money entirely on addition to the income-tax. The standard rate, applying to all taxable income after £165, was raised to 50 per cent, the initial rate was raised from 25 to about 33 per cent, and the exemptions and allowances were further reduced. The combined effect of income tax plus surtax was to place a practical limit on personal incomes, inasmuch as only about one thousand people in Britain would have gross incomes large enough to yield a net income of as much as £4,000. The most interesting feature of the 1941 budget was the adoption in modified form of the Keynes principle of deferred consumption. The Chancellor stated that one-fifth of all sums paid as excess profits tax will be returnable after the war for expenditure devoted to reconstruction, and that new money received as a result of the reduction in income-tax allowances will likewise be returned in the form of credits in the Post Office Savings Bank.

While subscriptions to various open government issues were well maintained, with funds continuing abundant, the monetary situation reflected the widening gap in war finance. The limit of the fiduciary issue of the Bank of England was three times raised during 1941, bringing the new total to £780,000,000 at the year's end. The note circulation expanded from £592,000,000 in October 1940 to £693,000,000 in October 1941 and £716,848,000 on Dec. 3. Deposits at the Bank of England showed no major changes; securities held advanced slightly from £153,300,000 in October 1940 to £163,300,000 a year later.

The commercial banks maintained a steady rate of expansion, deposits increasing from £2,661,000,000 in October 1940 to £3,115,000,000 in September 1941. Against these liabilities cash reserves increased in the same period from £270,000,000 to £330,000,000, securities held from £723,000,000 to £939,000,000, and Treasury Deposit receipts from £180,000,000 to £531,000,000. Discounts dropped from £373,000,000 to £315,000,000, and loans to customers continued the decline noted in 1940, falling during the period under review from £948,000,000 (corrected figure) to £839,000,000.

Interesting information was released by the United States Treasury in September 1941 as to the gold and dollar resources of Britain (or more correctly the sterling area) in America. At the outbreak of war these amounted to $4,483,000,000 comprising $2,038,000,000 in gold, $950,000,000 in marketable securities and the rest in dollar balances and direct investments. By Sept. 1, 1941 the total had shrunk to $1,527,000,000, gold falling to $151,000,000 and securities to $227,000,000. The approaching stringency was relieved by a 15-year loan of $425,000,000 from the Reconstruction Finance Corporation granted in July 1941 against securities and direct investments providing ample coverage for service and amortization; and the help provided under the Lend-Lease plan obviated most of the burden of future cash payments. There remained an estimated call for disbursements through February 1942 of over $1,000,000,000, half of which was to pay contracts placed prior to the Lend-Lease scheme. It was expected that most of this could be raised by sales of merchandise and gold, shipping, interest and other service credits, without entailing further heavy realizations of the remaining dollar assets.

The official exchange rate for sterling remained at $4.0350, and the free rate showed very narrow fluctuations in the twelve-month period ending with October 1941, from a high of $4.0356 in November 1940 to a low of $4.0310 in May 1941. Exchange controls were considerably tightened during the year, mainly to check the flow of money to dependents evacuated from Britain. Considerable inconvenience resulted in many such cases.

British Dominions.

War finance has, generally speaking, tended to produce similar results in the banking systems of all affected countries; namely, an increase in deposits arising from Government disbursements, a fall in commercial discounts and advances — either absolute or relative — due to the shrinkage of free industry, and a compensatory increase in investments, chiefly in government obligations. Canadian banks, however, showed a brighter picture, loans and discounts in the second half of 1941 attaining their highest totals for over a decade while security holdings showed only a slight advance over October 1940. Note circulation remained practically stationary, as did reserves. The situation reflected the 'pay-as-you-go' policy of the Canadian government, which resulted in war expenditures for 1941 being more than covered by revenue. The reduced total of non-war services, plus advances against British purchasing requirements, was met in part by increased taxes. A feature of the year was the war loan of June 1941 in which $730,000,000 was raised by 968,000 individual subscribers. The current tax system, at the close of 1941, included a 5 per cent defense tax on income above $660 in addition to the sharply graded income tax, a minimum of 40 per cent on business income, and an excess profits levy of 79 per cent.

In South Africa the predominant factor in the financial situation has been the high price of gold, resulting in a very favorable balance of payments, a large increase in deposits and a strong cash reserve position. Commercial advances showed a continued decline, possibly in consequence of the bulk purchases of wool and corn by the British government. Defense expenditures for the year 1941-42 called for a 20 per cent increase, of which more than half was to be raised by internal borrowing in which the banks were expected to participate heavily. The situation in Australia, for the year ending in June 1941, showed a steady expansion of bank deposits along with declining commercial advances. The percentage of deposits covered by advances in the Commonwealth Bank dropped from a 1940 average of 28 to 17.5 in June, 1941; for commercial banks the decline was from a 1940 average of 81 to 79. Advances have been carefully limited to enterprises of value for war purposes, and new investment is under strict control. A determined effort has been made to finance war expenditure out of taxes and savings. In New Zealand the rise in deposits and in note circulation was accompanied by a general strengthening of the financial situation due in part to exchange and import controls established before the war, also to the favorable British market for New Zealand exports. The budget presented in July 1941, while imposing no new normal taxation, counted on a higher yield of existing taxes to offset new war expenditure, together with internal borrowing sufficient to balance the account, including some expansion of the numerous social services.

France.

While publication of all regular statistical information ceased in 1940, some indication can be given of the financial situation with which the French government has had to cope. Short-period budget estimates have been issued showing a total expenditure of 40,000,000,000 francs for the first, and 33,000,000,000 for the second quarter of 1941, the decrease being due to cuts in the extraordinary budget and in the public debt service. From May 10, 1941 the item for costs of occupation was reduced from 400,000,000 to 300,000,000 francs a day. Since most of this is spent by the Germans in France, an abundance of cheap money is in evidence; bank deposits and savings have increased and Treasury bills have been easily absorbed. Despite continued advances by the Bank of France, and the prospect of a considerable deficit at the year's end, gold cover for the franc stood at 24.5 per cent in December and no runaway inflation had developed.

Following the last devaluation of the franc in March 1940, gold held by the Bank of France remained steady at 84,600,000,000 through August 1941 — the latest available date. At the close of that month note circulation stood at 244,000,000,000 francs as compared with just under 200,000,000,000 a year earlier. Advances to government for occupation costs rose in that period from 27,200,000,000 francs to 117,500,000,000. Private deposits of the Bank were up slightly from 28,200,000,000 to 29,100,000,000.

In the first week of January 1942 the Vichy government promulgated, for the first time since the armistice, budgetary estimates for the complete calendar year. Estimated receipts are set at 80,000,000,000 francs, nearly 18 per cent above 1941; ordinary expenditures amount to 105,500,000,000 francs, an increase of about 8 per cent, due to increased pay and pensions for state employees voted in 1941. The supplementary budget shows expenditures of fr. 33,000,000,000, a decrease of 4,300,000,000. These expenditures consist mainly of sums due for settlement of war contracts and credits for public works; they include also certain social expenditures, and a sum of fr. 3,000,000,000 to cover the deficit between the cost of wheat and the fixed price of bread. Beyond both the ordinary and the supplementary budgets lies an amount of from fr. 115,000,000,000 to fr. 120,000,000,000, being the sum the government will have to pay Germany for costs of occupation and certain additional charges.

Out of the estimated receipts for 1942, about 23 per cent is to be collected from direct taxation; a considerable increase over 1941 being expected from higher returns on existing taxes rather than higher rates. Indirect taxation is increased by new duties on wines, alcohols and the sale of business properties, and the state plans to collect higher revenues from postal, telegraph and telephone services which have been run at a loss.

The estimates show that in 1941, total surplus expenses over receipts, including sums paid to Germany, amounted to fr. 200,000,000,000, while the increase in advances to the state by the Bank of France was fr. 70,000,000,000. The Treasury was evidently able to place its obligations without difficulty notwithstanding that the rate on two-year Treasury bonds was cut from 3 to 1 per cent. It is also stated that during the past two years the foreign debt of France has been reduced by 50 per cent.

The financial year in France was marked by the abundance of funds available at low interest rates. The Bank of France reduced its rate on March 17, 1941 from 2 to 1 per cent, and the government took advantage of the situation to effect wide conversion operations, as did many private concerns. Fixed interest securities showed a corresponding rise, the 3 per cent rentes going from 70 in 1940 to 96 at the end of 1941, and the 4 per cents from 82 to over 103. Stocks responded to the combination of easy money with rising industrial activity in a spectacular rise — based however on a very narrow market. The index for thirty leading issues, which stood at 229 in 1939 and 261 in 1940, reached 706 in October 1941, when restrictions were imposed. While Finance Minister Yves Bouthillier, in reporting his budget, claimed that France had 'escaped the danger of monetary collapse,' the fear of inflation was not entirely banished at the close of the year.

French industrial concerns in many cases expanded considerably during 1941, much of the new capital coming from abroad; and in the dye and chemical industry, the heavy metals, the insurance business and other fields, close integration with German enterprise was established (see World Economics). Food and fuel remained tragically scarce, owing not only to German purchases and requisitions but to low productivity.

Nazi-Dominated Europe.

In Germany proper the outstanding financial event of 1941 was the stock market boom, which raised the share price index from 133 at the outbreak of war to 217 on Aug. 31, 1941. This represents the pressure of spare funds seeking investment coupled with the shrinkage of free markets, the severe restrictions on new issues, and a possible inflation hedge. Meanwhile government revenue, derived as to about 70 per cent from income tax, corporation tax, and turnover tax, increased by 19.7 per cent for April-September 1941 over the corresponding period of 1940; total revenue for the financial year 1941-42 was expected to be about 17 per cent higher than for 1940-41. Government borrowing, however, increased at a higher rate, and despite a 25 per cent increase in the corporation tax in August, 1941, somewhat more than half the war cost was carried by Treasury bills. The Reichsbank's note circulation on September 30, 1941, was 16,917,876,000 marks, approximately double the pre-war figure.

In the occupied countries note circulation has everywhere increased, with price advances running from 30 to 80 per cent in the first two years of war. Strict German control of currency exchange rates has been used in favor of the occupying forces and the import requirements of the Reich, and the central banks have thus acquired large amounts of blocked reichsmarks which serve in effect as note cover. A marked extension of German commercial banking, especially in south-eastern Europe, has played an important part in the attempted reintegration of the European economy with Germany as the focus. While inflationary tendencies were everywhere latent, the strict controls imposed on prices, wages, the movement of labor and the foreign exchanges have so far kept the financial situation in hand.

Latin America.

The repercussions of the war increased in severity with the extension of its area, and necessitated further exchange controls and trade restrictions in practically all Latin American countries. Changes in the direction of foreign trade were sudden and sweeping, though not in all cases disadvantageous. The energetic British trade drive of recent years was perforce curtailed as Britain concentrated her exports on sources of more urgent military supplies; though British purchases of meat remained heavy. Concurrently, Britain negotiated bi-lateral payment agreements with nearly all the republics on lines similar to those of the Argentine agreement of 1936, with somewhat less option as to the use of sterling for payments to third parties. The Japanese trade drive, which made rapid headway during 1940, was intensified in 1941 in consequence of the increasing uncertainty of relations with North America and the abrogation by the United States of her trade treaty with Japan. Demand was heavy for Argentine meat and wool, copper and nitrates from Chile, cotton from Brazil and Peru, mercury from Mexico, Venezuelan and Mexican oil, scrap iron, mercury and other commodities; but the freezing of Japanese assets by Britain and the United States hampered the financing of these purchases. The blacklisting by the United States of all economic enterprises of its enemies seriously embarrassed considerable areas of Latin American industry and agriculture; and the increased risks of shipping on both oceans diminished the volume and enhanced the costs of maritime trade.

Heavy additional defense expenditures were undertaken by certain countries, notably Uruguay, Brazil and Chile, but the cost of Latin American defense was largely offset by lend-lease aid and Export-Import bank loans from the United States. The conclusion of the reciprocal trade treaty with the Argentine marked the twelfth such agreement negotiated under the Hull program. Several currency stabilization agreements were also concluded during the year; and the successful termination of the discussions for an all-round settlement with Mexico, promising large new loans, a continuance of silver purchases and an early trade agreement, marked a further advance in hemisphere solidarity. Nicaragua continued to profit by its newly discovered gold, exports rising from $1,550,000 in 1938 to $5,700,000 in 1940 with a prospect of possibly $8,000,000 in 1941. In this as in all other cases, the increasing financial and economic dependence of Latin America upon the United States was the outstanding feature of the year.

At the end of 1940 United States holdings of Latin-American bonds amounted to $993,100,000 compared with $1,039,600,000 a year earlier. Of the 1940 total $606,300,000 were in complete default, a proportion somewhat lower than that for Central America only.

Far East.

The war effort of Japan, which reached its crisis in the events of December 1941, has entailed a strict control of every aspect of economic life, including a more severe rationing system than that of any other belligerent. Since the normal standard of living is low, the tax base is narrow, and war expenditures have been carried largely on loans taken up by commercial banks and the great corporations. The internal debt, which stood at about 10,000,000,000 yen in 1937, had tripled by mid-1941. Note circulation of the Bank of Japan rose from 3,636,000,000 yen in October 1940 to 4,484,000,000 in September 1941. Private deposits in that period expanded from 127,000,000 to 321,000,000 yen, and holdings of government bonds rose from 2,923,000,000 to 4,118,000,000. Discounts declined from 755,000,000 to 517,000,000, reflecting the commercial stringency. In the commercial banks deposits increased from 21,885,000,000 in August 1940 to 34,521,000,000 in July 1941. The foreign exchange rate remained pegged at 23.439.

The wholesale price index, based on 1900, advanced from 310 in October 1940 to 337 in October 1941; retail prices, on the basis of 1931 = 100, stood at 196 in May 1941. In both cases the price levels were affected by controls reaching almost all commodities. Japanese wage-rates, on the same 1931 basis, stood at 116 in March 1941, earnings at 167.

Statistics for China are almost entirely lacking, though the expansion of Chinese government banks throughout west and southwest China has been marked. These banks, like the Bank of China itself, are principally engaged in the financing of the many lines of government enterprise in free China; the needs of war and reconstruction, coupled with the progressive inflation, leave little of either demand or supply for private financing. Money rates of the old private banks run in the interior as high as 30 per cent, with rural credit prohibitive; and the extension of government banking is counted on to relieve this situation. Similarly, interior prices are multiplied to several times the Shanghai or Hongkong figures, with speculation, hoarding, and profiteering a constant problem. Yet while lend-lease aid and government loans from the United States and Great Britain have played a major part in the support of independent China, great advances have been made in the utilization of native resources under government control. Mines, power-plants and industrial establishments have been developed and important railroad construction has been undertaken. See also BANKS AND BANKING; WORLD ECONOMICS.

1940: International Banking And Finance

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.

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.