Between 1776 and 1815, Britain was at peace for just 10 years, and reading the Scottish defense of free trade without this in mind is a mistake.
Even before the guns of August 1914 shattered the long European peace and marked the opening of a catastrophic war whose consequences linger a century later, a largely forgotten crisis almost threw the global economy into turmoil. Richard Roberts aptly describes the 1914 financial crisis sparked by unfolding political tensions as a hair-raising episode featuring a comprehensive breakdown of market operations that involved a greater systemic challenge than crises in 1866 or 2007-8. It was the first instance of global financial contagion. The prospect of bank failures threatened to upset other economic sectors by denying both the means of transferring payment and the cash or credit needed for regular operations. While London became the epicenter as the major clearing house for international transactions, over fifty countries were swept up in the panic. Junnosuke Inoue, president of Japan’s Yokohama Specie Bank, much later called it “one long, evil nightmare” that still haunted his dreams. Success in containing the crisis and then brining about a recovery, albeit under very different wartime circumstances, perhaps did almost as much to eclipse the memory of it as the larger political catastrophe of the First World War.
Roberts accordingly provides a very useful service in Saving the City by giving a detailed, though admirably clear, account of London’s response to the 1914 financial crisis. Besides contributing to historical scholarship by recovering a largely forgotten, but important episode, his book adds a valuable case study to the literature on financial panics and policy responses to manage them. Mervyn King, who served as the Bank of England’s governor during the recent 2007-8 crisis, points out in a forward that 1914 offers a more helpful parallel to those events than the more commonly invoked Great Depression of the 1930s. Britain, at least, faced no banking crisis in the 1930s, and the immediate circumstances and response in 2007-8 differed sharply enough to make comparisons misleading. The wider systemic risks posed by the collapse of financial markets where the speed of communications quickens decision-making thus heighten the value of understanding 1914. Other events since King’s tenure also point to the importance of how political risk affects market operations.
Domestic politics, especially a looming crisis in Ireland over Home Rule, had been the main concern during the otherwise quiet summer months when businesses and their employees anticipated an upcoming bank holiday. News of Austria’s ultimatum to Serbia on Thursday, July 23 came like a bombshell that transformed risk perceptions with the prospect of a European war on a scale unseen since Napoleon’s final defeat in 1815. A scramble for cash brought widespread selling of equities that drove prices down and encouraged further selling as purchasers withdrew and prices became unreliable. Falling values upset the balance sheets of many banks holding equities marked to the market price. What began as a voluntary process in response to political news accelerated when the decision by foreign banks to call in loans and repatriate the money forced the sale of collateral for payment. Bonds—a major part of the London Stock Exchange—fell in value along with equities. The global scramble for liquidity, as Roberts demonstrates, broke the mechanisms by which the market operated. Unease grew as firms on the London Stock Exchange failed, but news on July 30 that the Paris Bourse had postponed settlement of accounts imperiled trading houses with even the strongest credit. With the prospect of another wave of panic selling, the London exchange closed on July 31. Provincial exchanges in Britain followed as did their counterparts in New York and across the United States. Closure lasted six weeks and marked what Roberts calls a unique moment in economic history as the first example of a global financial contagion.
The collapse of international remittance drew less public attention than the drop in stock exchange prices that ended with trading suspended, but it had dangerous repercussions. Global trade involved daily and short term payments through London, whose credit markets provided the bills that served as a medium of international exchange. When London banks called in payment and declined issuing bills they not only pressured foreign banks, some of which declared moratoriums on payments and suspended business, but also withdrew the means by which international commerce settled its accounts. On August 1st the Economist warned that the world seemed to be “returning to a basis of cash and barter.” Cash raised the exchange rates for currency as sterling fell against the franc and dollar. Rebalancing involved shipping either goods or gold since the latter backed major currencies, but the remittance crisis and impending military operations had suspended trade. A spike in the demand for gold risked a run on banks as depositors sought possession of their savings to avoid total loss. Indeed, the sterling-dollar problem indicated the wider repercussions of a London crisis as shipping gold to remedy it threatened a bank panic in the United States.
Concerns about hoarding gold—primarily in coin—joined the larger crisis with dynamics in Britain. Individuals and businesses needed cash to meet regular expenses, including employee wages and small purchases below even the smallest denomination note issued by the Bank of England of £5. Even without fear of banks closing or having cash on hand to replace tightened credit, demand for gold sovereigns limited flexibility for institutions whose portfolio value had fallen just as calls on their assets grew. Overseas demands for gold and the prospect of banks holding the metal back to protect their own liquidity now threatened a bank panic that once started would be hard to check.
The situation in 1914 differed from what the economic historian Charles Kindleberger has described as a typical financial crisis. No credit expansion, speculative bubble, or spike in asset prices gave the usual indications of instability. The displacement event transforming risk perceptions—Austria’s ultimatum to Serbia that escalated political tensions—sprang from causes outside the economy. Drawing on experience with the 1866 financial panic, Walter Bagehot had urged that the Bank of England serve as a lender of last resort and provide loans freely but at a high rate. Providing funds on those terms would prevent banks from failing under short term pressure while deterring borrowers not in dire need. Bagehot’s rule for crisis management guided responses to episodes before 1914, but now the scale of the crisis demanded more resources than the Bank of England and other private institutions could provide.
Management of the crisis shifted from the Bank of England to Whitehall on July 31, although bankers initially took the lead in discussions. They proposed suspending the 1844 Bank Act that limited the Bank of England’s issue of notes and depositing gold from other leading banks with its Issuance Department as a confidence building measure. Making a substantial bank note issue available to other banks would enable them to meet customer demand. These proposals offered a starting point for a much larger government intervention that stemmed panic, revived confidence in financial institutions, and offered traders the banking facilities they needed for business. Roberts gives a detailed account of deliberations and their ultimate resolution. Issuing Treasury notes prevented an internal drain on specie without formally suspending the Bank Act. Declaring a moratorium on bills where crisis impeded regular payment marked another step followed by the Bank of England purchasing bills on a wide basis with the government’s guarantee to clear the market. Removing derelict bills while assisting participants in the market helped preserve its structure to provide a valuable tool for wartime finance as treasury bills replaced commercial ones. The overall response turned out to be an unprecedented intervention by either government or bank, but one that worked.
Fixing the foreign exchange problem took longer, but, again, containing the crisis enabled the first step toward recovery. The resumption of normal trade, once insuring and shipping problems were resolved, allowed goods rather than gold to rebalance sterling-dollar convertibility. Allied demand provided a ready market for American produce even if the war largely closed other markets. With the reopening of the London Stock Exchange on January 4, 1915 business returned to the new normal of wartime operation. Restoring the London financial markets played a key part in facilitating loans and other measures the war demanded.
Although Roberts correctly describes the 1914 crisis as unexpected at the time, a few experts had foreseen the potential impact of a general European war. Lord Revelstoke, a leading financier and former Bank of England director, warned a Committee of Imperial Defense inquiry during the winter of 1911-2 that a European war would bring stupendous chaos to commerce and industry that, in turn, would cause a run on joint stock banks. Edgar Crammond had given a paper before the Institute of Bankers in May 1910 advocating higher gold reserves to hedge against a monetary crisis at the start of a war. Naval strategists, as Nicholas Lambert demonstrates in Planning Armageddon: British Economic Warfare and the First World War (Harvard: 2012), saw the leverage provided by London’s control over commercial finance, insurance, and shipping as an alternative to a blockade that would compel Germany to submit or face ruin. Finance proved such a potent—an uncontrollable—weapon that the British government drew back from deploying it to the fullest extent. Neutral powers, including the United States would have suffered massive collateral damage from efforts to bring down Germany’s economy. Lambert’s story underlines the interconnectedness that Robert’s emphasizes in Saving the City.
Readers today, like Mervyn King, doubtless look for lessons from the 1914 crisis, but that kind of analysis lies beyond the historian’s remit. Easy analogies can mislead as much as they illuminate, but a few points shine through from Roberts’ fine study. Once a crisis reaches a certain scale it risks sending a self-reinforcing cycle through markets that justifies government action to stabilize markets. Intervention here aims not to manage or guide markets towards politically determined preferences but to contain market failure and enable recovery. As Bagehot noted in the 19th century, the psychology of financial panic matters and that demands restoring confidence. Doing so effectively minimizes the risk for taxpayers as markets return to normal operations. Britain’s Treasury made a nominal profit of £6.5 million from its 1914 guarantees. The consequences of “thick interdependence” among trading partners turned adversaries is another important point. Norman Angell famously argued that globalization made war unthinkable, but he proved only half-right. War proved doable as well as thinkable, albeit with the result of turning economies along with governments and societies upside down.