Economics / History / Warfare

Aggregate Demand Dominance: 300 Years of War Finance

The Utter Failure and Stupidity of the Gold and Silver Standards: Part 2

My previous posting posits there is an inextricable connection between warfare and inflation/gold prices going back centuries. The connection also reaches to the origins of central banks.

The Sveriges Riksbank is the oldest central bank that still continues to operate, succeeding the Stockholms Banco in 1668. The Swedish central bank’s predecessor was founded in 1656 amidst the Second Northern War, where somehow Sweden managed to get itself embroiled in four separate conflicts in the span of five years. The Sveriges Riksbank itself was founded in the aftermath of the War of Devolution. The founding of the second-oldest central bank less than three decades later would shape both world finance and world history.

We Need A Navy…

The Bank of England was chartered in 1694 amidst the continent-wide Nine Years’ War, specifically to finance the rebuilding of the Royal Navy:

The origin of the Bank of England lies in naval warfare.  In 1694, the French had the strongest navy in the world and following the 1690 Battle of Beachy Head, England needed to rebuild its navy, but King William III lacked the resources and the credit to do so.

This problem was resolved by creating the Bank of England.  In exchange for creating a limited liability corporation, which would act as a bank for the government and have the right to issue banknotes, the shareholders would loan the bank £1,200,000 at 8% interest.  The Royal Charter was granted on July 27, 1694 and the £1,200,000 was subscribed in only 12 days.

A corresponding 1688-1697 war was fought in North America between the English and French belligerents, a trend that was repeated during the Seven Years’ War/French and Indian War. Two more trends would also be established at the close of the seventeenth century—naval technology’s preeminence, and a total lack of understanding of how financially destabilizing military expenditures were to become.

…We Need Naval Dominance…

During the eighteenth and nineteenth centuries, the Royal Navy became a powerhouse the world had never seen before or since:












The size of the Navy, which built vessels frantically and captured others from its enemies, reached a peak of 152 battleships and 183 frigates in 1810. Taking into account the smaller ships of war, such as sloops, brigs and corvettes, there were probably close to 1,000 vessels flying King George III’s ensign.

In the highly unlikely event this posting is ever read by someone other than its author, I would have to defend my statement as clearly modern warships could obliterate the RN’s wooden sailing ships-of-the-line dating from 200 years ago. However, even after the U.S. Navy eclipsed the RN during World War II and remains the world preeminent sea force to the present day, the prospect of squadrons of warships sailing up and down coastlines terrorizing huge numbers of people is almost unthinkable today (the only possible modern exceptions to the terror rule, ballistic missile submarines, strike fear due to nuclear weapons rather than the warships and their crews themselves).

Britain established a formidable naval empire, both merchant and military. More important than massed gun platforms like the HMS Victory was the system of commerce that Britain likewise ruled, the most important institution being the Bank of England. Engaging in commercial banking in addition to its duties to the Crown, the BOE blew up speculative bubbles in North America before the arrival of its menacing old antagonist.

…Before the French Kill Us All

The French fleet had mauled the English at Beachy Head, which might explain the extreme overreaction 106 years later:

On 21 December 1796, a French fleet arrived at Bantry Bay, Ireland. Though the French did not land, because of bad weather and confusion in the command, they stayed in the Bay for two weeks without an attack from British fleet, which was then in Spithead. The invasion of Bantry Bay has not been featured in most economic histories, but in fact, this event caused a financial crisis in Ireland, a crisis that preceded the Newcastle panic. Cork, which was situated close to Bantry Bay, was also seriously affected by the event. On 6 January, it was said that ‘all Business here is at a stand, no Money in Circulation but what is paid Tradesmen & Labourers.’[1] The shortage of money – which means coins – undoubtedly started immediately after the arrival of the French fleet, for the City of Cork Committee referred to an ‘alarm’ on 24 December. What is more significant about the Cork Committee is that, on this occasion, the Committee recommended stopping cash payments, and that recommendation was obligingly adopted by the Cork bankers.

Hiroki Shin goes on to claim “the suspension in Cork did not lead to a bigger crisis,” but that’s only because the French upped the ante two months later:

The French invasion force comprising some 1400 troops set sail from Camaret on February 18th, 1797. The man entrusted by the Directory to implement their ‘cunning plan’ was an Irish-American septuagenarian, Colonel William Tate. As Napoleon had apparently reserved the cream of the Republican army for duties elsewhere in Europe, Colonel Tate’s force comprised a ragtag collection of soldiers including many newly released jailbirds. Tate’s orders were to land near Bristol, England’s second largest city and destroy it, then to cross over into Wales and march north onto Chester and Liverpool. From the outset however all did not proceed as detailed in the ‘cunning plan’. Wind conditions made it impossible for the four French warships to land anywhere near Bristol, so Tate moved to ‘cunning plan’ B, and set a course for Cardigan Bay in southwest Wales.

In other words, a nuisance raid.

On Wednesday February 22nd, the French warships sailed into Fishguard Bay to be greeted by canon fire from the local fort. Unbeknown to the French, the cannon was being fired as an alarm to the local townsfolk. Nervously the ships withdrew and sailed on until they reached a small sandy beach near the village of Llanwnda. Men, arms and gunpowder were unloaded and by 2 am on the morning of Thursday February 23rd, the last invasion of Britain was completed. The ships returned to France with a special despatch being sent to the Directory in Paris informing them of the successful landing.

Upon landing, the French invasion force appear to have run out of enthusiasm for the ‘cunning plan’. Perhaps as a result of years of prison rations, they seem to have been more interested in the rich food and wine the locals had recently removed from a grounded Portuguese ship. After a looting spree, many of the invaders were too drunk to fight and within two days, the invasion had collapsed: Tate’s force surrendered to a local militia force led by Lord Cawdor on February 25th 1797.

But the French failure had spectacular economic aftereffects the following day:

On 26 February 1797, in spite of it being a Sunday, the Privy Council convened to discuss measures of preventing the country’s financial ruin. The reserves in the Bank of England were dangerously low, and the news that a French squadron had landed on the coast of Fishguard, Wales, had just reached the capital the previous day. On the following day, people who went to the Bank of England were given handbills, which communicated that following the Order of the Privy Council the Bank had suspended the cash payments of their notes.

Suspending cash payments meant shifting the basis of trust in the financial system. It involved a sharp increase in the number of people who dealt with paper instruments which, unlike precious metals, depended directly on the workings of the system rather than on personal relationships and intrinsic worth.

That “system” had freaked out over an incredibly inept invasion, setting a new model for war finance:

Year British Official Price
(British pounds per fine ounce
end of year)
London Market Price
(British £ [1718-1949] or
U.S. $ [1950-Present] per fine ounce)
1797 4.25 £ 4.23
1798 4.25 £ 4.25
1799 4.25 £ 4.24
1800 4.25 £ 4.26
1801 4.25 £ 4.29
1802 4.25 £ 4.31
1803 4.25 £ 4.34
1804 4.25 £ 4.36
1805 4.25 £ 4.36
1806 4.25 £ 4.42
1807 4.25 £ 4.47
1808 4.25 £ 4.52
1809 4.25 £ 4.58
1810 4.25 £ 4.63
1811 4.25 £ 5.19
1812 4.25 £ 5.48
1813 4.25 £ 5.76
1814 4.25 £ 5.21
1815 4.25 £ 4.99

 Rather than raise the controlled price of £4.25 per troy ounce of gold that had held through every major English war up to and including the 1690s, the newly-developed 1790s “system” would wring the wartime inflation out of the economy with no consideration how long such a depression might last or how many people it might starve to death. By the late nineteenth century, the depressions began lasting decades.

Transition to Modern War

Britain would be spared the abject violence that accompanies mechanized warfare for a century after Napoleon was defeated once and for all, but not its former colony in North America. I already dug deeply into the economic damage wrought by the War of 1812 (the near-annihilation of the United States of America led to bankers unilaterally suspending specie in August 1814) and the horrific 1837 Depression, but that was just a warm-up compared to the Civil War.

The Union Army rose from 16,000 soldiers in the prewar Regular Army to 670,000 by the end of 1861, perhaps giving American banks their excuse for suspending specie on 30 December 1861. Another possibility was the U.S. Navy’s attempts to avoid a Beachy Head.

Old enemies Britain and France had transitioned from the stream-powered naval arms race to the ironclad arms race in 1859, but it was two American vessels that fought the first ironclad battle. U.S.S. Monitor’s rotating armored armament was a marked departure from fixed broadsides, the superior turreted gun become the standard for all subsequent fighting ships. Other innovations would include the rapid-fire Gatling gun, which would eventually be modified and miniaturized into the machine gun. This first introduction of mechanization to warfare resulted in far more dead and injured than similar-scale 19th century wars, which was reflected in the inflation of gold and silver prices:

Year U.S. Official Price
(U.S. dollars per fine ounce
end of year)
New York Market Price
(U.S. dollars per fine ounce)
1861 20.67 20.67
1862 20.67 23.42
1863 20.67 30.02
1864 20.67 42.03
1865 20.67 32.52
1866 20.67 29.13
1867 20.67 28.57
1868 20.67 28.88
1869 20.67 27.49
1870 20.67 23.75
1871 20.67 23.09
1872 20.67 23.24
1873 20.67 23.52
1874 20.67 22.99
1875 20.67 23.75
1876 20.67 23.05
1877 20.67 21.66
1878 20.67 20.84
1879 20.67 20.67

 The American transition to the gold standard was completed in 1879, an act that chained the former colony to the highly-stupid British gold price control “system.”

Undoing the Work of Depressions

Joseph Schumpeter famously stated “artificial stimulus leaves part of the work of depressions undone,” perhaps implying that economic depressions and recessions are caused by natural forces which should not be interfered with. The stupidity of this statement only becomes apparent when one considers the fact that Britannia never played by the rules—she simply rewrote them.

Naval development took on an obsessive quality between 1906 and 1914. First Sea Lord Jacky Fisher, learning from the Japanese at Tsushima that guns less than 12 inches in diameter aren’t accurate or powerful enough to inflict much damage in a battleship versus battleship duel, mounted only big guns to a ship propelled by the Parsons turbine. The resulting battleship, HMS Dreadnought, outclassed everything on the sea (including every capital ship in the RN). Paradoxically, the instant obsolescence of every battleship ever built prior to 1906 enabled Germany’s industrial might to build the High Seas Fleet while Britain was forced to rebuild the Grand Fleet. Also, it made Britain paranoid to the extreme—the likelihood that the British would join Germany in any alliance once the Kaiser’s fleet became the second most numerous worldwide became essentially nil.

Britain’s finances were taxed to the limit building its battle fleet, which undoubtedly played a role in the massive financial crisis that struck in July and August of 1914:

The week beginning Monday 27 July saw the breakdown of the City’s foreign exchange and discount markets, and culminated in the closure of the London Stock Exchange on Friday 31 July. It stayed shut for five months. Long queues formed at the Bank of England of people changing Bank notes for gold sovereigns. It looked like a run on the Bank was underway. And it was believed that a run on the banks had begun.

There had been no pre-war planning for such a crisis. Time was bought by the declaration of an unprecedented four-day Bank Holiday. During the break, at 11 pm on Tuesday 4 August, Britain went to war. The initial emergency containment measures were massive infusions of liquidity by the central bank plus a hike in the discount rate from 3 per cent to 10 per cent, following established crisis management doctrine. Then came novel policy measures: a “general moratorium” on contracted payments (which allowed banks to refuse to pay out deposits), and the introduction of hastily printed small denomination currency notes issued by the Treasury (not the Bank of England). When the banks reopened on Friday 7 August there was no run. The crisis had been contained.

Gold prices did not rise above the 4.25 or 20.67 price controls during the war, but the new system triggered huge recessions in both countries as the 1920s began. Nor did the naval race abate at first—the U.S. Navy attempted to out-build the Royal Navy until the Washington Naval Treaty of 1922 shut off the tap—the construction of all capital ships was halted and dozens were scrapped. The next congressional authorization for American naval construction would not come until eight long years had passed, entitled the Cruiser Act. As memory serves me, economic prospects were not good in 1930…

Twilight of the Twenties

Am I blaming naval construction for triggering the Great Depression? Not at all—the Washington Treaty might have pushed the Depression further into the future, as the naval race had nearly bankrupted Britain prior to the outbreak of the First World War. The Treaty likewise prevented animosities from developing between the American and British navies during the 1920s, perhaps preventing and Anglo-American war.

But the folly of the gold standard’s price controls is evident in retrospect. Britain resumed the gold standard in 1925, and deflation immediately set in:

1934 0.00%  
1933 -2.10%  
1932 -2.60%  
1931 -4.30%  
1930 -2.80%  
1929 -0.90%  
1928 -0.30%  
1927 -2.40%  
1926 -0.80%  
1925 0.30%  

…for both the British and Americans:

Historical Data Chart

Wait, Britain “abandoned” the gold standard in 1931. Why did it take so long for inflation to turn positive?

Year British Official Price
(British pounds per fine ounce
end of year)
U.S. Official Price
(U.S. dollars per fine ounce
end of year)
New York Market Price
(U.S. dollars per fine ounce)
London Market Price
(British £ [1718-1949] or
U.S. $ [1950-Present] per fine ounce)
1925 4.25 20.67 20.67 £ 4.27
1926 4.25 20.67 20.67 £ 4.25
1927 4.25 20.67 20.67 £ 4.25
1928 4.25 20.67 20.67 £ 4.25
1929 4.25 20.67 20.67 £ 4.25
1930 4.25 20.67 20.67 £ 4.25
1931 4.25 20.67 20.67 £ 4.63
1932 4.25 20.67 20.67 £ 5.90
1933 4.25 20.67 24.44 £ 6.24
1934 4.25 35.00 34.94 £ 6.88
1935 4.25 35.00 35.00 £ 7.11

 Is it a coincidence the deflationary squeeze ceased after gold’s price controls were lifted by 70% in 1933, the first revaluation in a century?


One thought on “Aggregate Demand Dominance: 300 Years of War Finance

  1. Pingback: Aggregate Demand Dominance: MIC and the Death of the Deflation Ratchet | In The Corner, Mumbling and Drooling

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