Popular Science Monthly/Volume 86/April 1915/Future Banking Problems of the United States with Reference to the European War
|FUTURE BANKING PROBLEMS OF THE UNITED STATES WITH REFERENCE TO THE EUROPEAN WAR|
By Professor THOMAS CONWAY, Jr.
UNIVERSITY OF PENNSYLVANIA
PUBLIC opinion in the United States concerning the effect of the great European war upon this, country has passed through several distinct stages. The first period was of brief duration. Many people, recalling the prosperity of this country during the Napoleonic wars, jumped to the conclusion that it would bring financial and commercial prosperity to us.
This delusion, for such it may be termed, was rudely shattered by the consequences which followed thick and fast during the first few days of August. Our stock exchanges closed even before war was officially declared, the cash reserves of our banks were reduced almost over night below the minimum prescribed by law, emergency currency in very. large amounts must be issued, interest rates soared, banks advised retrenchment and caution, orders were cancelled, factories closed or operated only part-time, while cotton became not only unsalable, but of unknown value as collateral.
In the face of such circumstances, of which these instances are illustrative, public opinion entered upon the second stage. Pessimism abounded. Fears for the safety of friends and relatives abroad, coupled with highly colored, but inaccurate, news from the seat of war, led to the greatest apprehension. We came to regard Europe as wholly mad, destroying everything; suddenly bereft of all business prudence or sound sense. In this period arose the hysteria of a German invasion of our shores, although a hundred times further removed than the English coast, apparently unattainable to her. During this period arose the dread of uncontrollable foreign liquidation of American securities and of our banking system, drained of every dollar of its gold reserve. Happily this period of horror and depression has nearly ended.
We are now in a more cheerful frame of mind. On every side one hears the hope expressed that we have passed through the worst of the effects of the European war. It was inevitable that the sudden outbreak of the struggle, coming without warning, should disorganize the machinery of production, and cause universal hesitation, retrenchment and caution. It is argued that the American business man has had an opportunity to survey the situation, to ascertain to what extent his trade has been affected by the new conditions, and that now, after five months of study, he is prepared to once again push forward along the lines which have been least affected by the changed conditions.
This more cheerful frame of mind is stimulated by the news leaders in our daily press. Mr. Charles M. Schwab's alleged interview, in which he asserted that there were over $300,000,000 of orders for war materials in process of manufacture, has been given the greatest prominence. Every mill which has received a contract or to which an inquiry, real or alleged, has been directed concerning the sale or manufacture of blankets, automobiles, cartridges, rifles, cannon, clothing, harness and saddlery, oil, copper, and in fact the vast range of articles which are being consumed in this struggle, has been given prominence.
In spite of this optimism we must realize that in New York City over one hundred thousand men are out of work, while the army of unemployed in the entire country is estimated by responsible observers to be as high as one million in number. As Judge Gary, of the United States Steel Corporation, has well said, the need for aid for the unemployed is perhaps greater than the need of the sufferers in Belgium. Nor does such a conclusion proceed from any failure to appreciate conditions in the devastated regions. No one can understand the want or misery which will afflict millions of deserving, thrifty people in Europe. With the German casualty list much delayed, thereby minimizing the totals of killed, wounded and missing; with France and Russia unwilling or unable to announce but a small fraction of their losses in men; with the English losses largely to come, because only a small proportion of the allied army has thus far been made up of her troops, the world has yet to realize the tremendous destruction of workers which the war has already entailed and which each additional day will bring. Any estimate of this loss is at best but an approximation, but it seems likely that the first six months of the war will involve a loss of life greater than the entire loss on both sides in the four years of our civil war. Sociologists and the medical profession will, for a generation, be investigating and reporting upon the consequences, direct and remote, of the killing and maiming of such an enormous number of men.
It is natural, under such circumstances, that popular attention should give little or belated recognition to the tremendous losses in property which have occurred and which will occur. Popular interest seems to be chiefly concerned with the destruction of the architectural monuments of the past. As to the destruction of factories, warehouses, roads, bridges, farm buildings, and machinery, fences, dikes and canals, but little attention has been given.
We are appalled by the assertion that millions of Belgians are homeless and without means of support, particularly when told that a vessel load of food is needed every day to keep these people from actual starvation. We are only beginning to realize that this tremendous toll upon the charity of the world, largely upon the United States, must continue for many months, because the means by which this population can earn its own living have, to a large extent, vanished through the destruction of the agencies of production. Thus far we have heard little of the needs and condition of northern France in which a population almost as large, ordinarily finds employment, and where the destruction of property must have been fully as great.
We think of the losses and cost of the war as involving only the expenses of the belligerent governments, and yet this is the smaller part of the permanent drain upon the world. If the war should cease to-day, the belligerent nations would be solvent and could carry the enormous burden of debt which they have been forced to assume. The greatest loss, the suffering, privation and disorganization will come to the people of those districts over which the armies have tramped.
Lord Kitchener tells us that the war will take at least three years, if it is fought to a finish: there is no reason to presume that this estimate is not correct. A finish, as he views it, involves the gradual wearing out of Germany; the pressing back of her armies until they are forced to surrender at the gates of Berlin. If his hopes are realized, the losses of the war will be tremendously increased, for the path of ruin and devastation will reverse its course and Germany will, at the end of the struggle, be fully asas are Belgium and northern France to-day.
It is folly for any one, at this stage, to estimate the effect of the war upon American business and American financial conditions. From the few illustrative facts which I have set forth above, it is apparent that the duration of the war and the extent of its devastation will to a large degree, determine the effect of the conflict upon us. It has been apparent to every one that the duration of the struggle will directly affect its cost. The greater the cost, the larger the sacrifices which must be made, and the larger these sacrifices, the more profound will be the effect of the war upon neutral nations. We must bear in mind that the ability of the nations of Europe to bear the financial burdens of the war depends upon the extent to which their territory is ravaged and their lands, buildings and public works destroyed.
The governmental expenditures of the war, in so far as intelligent estimates can be made at this time, are running at the rate of $20,000,000,000 a year. The investment in new securities by the people of the countries at war, have heretofore been at the rate of about $4,000,000,000 per year. Even making all allowances for the diversion of capital from manufacturing industries to war loans and the results of unparalleled economies, it is apparent that the struggle is running far ahead of the normal rate of investment in times of peace, when business is going on and profits are being made by the belligerent nations. It is this disparity between saving power and direct and indirect expenditures which has given rise to the ever-present dread of an enormous liquidation of American securities.
There seems to be a persistent tendency to minimize and underestimate the foreign holdings of American securities. I have seen no newspaper or magazine which openly expresses doubt as to the extent of these foreign holdings, support its conclusions by reference to the painstaking official and unofficial studies of this subject made by foreign governments and by financial experts in times of peace. And yet every student of finance ought to be familiar with such a study as that made by Sir George Paish for our National Monetary Commission in 1909, if not with the original sources from which he drew his information. Five years ago. Sir George, in his scholarly study "The Trade Balance of the United States," declared:
Great Britain possesses about $3,500,000,000 of American securities. . . . The French investments in the United States, including the Pennsylvania Railroad and other loans placed in Paris, since 1902, amount to nearly 2,500,000,000 francs, or $500,000,000. . . . German bankers place the amount of German investments in American securities at about $1,000,000,000. The amount of Dutch capital in the United States is about $750,000,000. American securities are also held by Belgium, Switzerland and other countries. In the aggregate, the amount of European capital invested in permanent securities in the United States is approximately $6,000,000,000.
The British chancellor of the exchequer stated in the House of Commons, on December 1st, that "America, I suppose, owes us nearly £1,000,000,000 in fixed and floating capital," and in a later explanation he declared that he had reference to the British capital invested in the United States and in no way had in mind current American indebtedness which had been the subject of the discussions between Sir George Paish and the representatives of the United States treasury. We must bear in mind, moreover, that the indirect effect of English holdings of securities of corporations on the North American continent may be very profound. The general manager of the Bank of Montreal, in his address to the stockholders, at the annual meeting held on December 7, declared that British investors had, for a considerable period, been placing on the average $25,000,000 per month in Canada, Such investments had ceased with the outbreak of the war, and as he remarked.
Continuing, he throws an interesting but thus far little-noticed side light upon the effect of this sudden change upon the foreign trade of Canada and in fact of South America and all relatively undeveloped countries. He well states that
The trade situation we are now facing is that, owing to our present inability to borrow by public process in the London market, we seemingly must limit our imports to the approximate volume we are able to pay for in exports, or we must borrow elsewhere; that is, in the natural assumption that we wish to avoid reducing our cash capital. There is an alternative, for it will be obvious to the most uninitiated that if our good neighbors in the United States desire us to purchase from them in anything approaching the volume of the past, they must, at least during the war, while the London market for public flotations is closed, provide us with the wherewithal in the shape of loans to our principal public borrowers. If they adopt this course, and a commencement has already been made, it will be clearly advantageous to them and to Canada.
Thus it would appear that, at a time when we ourselves are fearful of having to repurchase securities from England, our Canadian, and perhaps also our South American neighbors, are looking to us to maintain ourtrade with them, in a measure taking the place which England has heretofore held, by investing money in their enterprises.
It would be well for economists and bankers to read at this time Sir Robert Giffen's celebrated essay on "The Liquidations of 1873-76." This advice is especially apropos for those who see such rosy prospects for advantageous trade in South America and the other relatively undeveloped areas of the world. If history repeats itself the greatest danger, in a financial sense, will occur after the close of the European War and will be particularly great in the countries of South America, Central America, Canada, in fact all of the relatively undeveloped areas of the world. I do not want to be understood as discouraging the development of South American trade, but American manufacturers and exporters must proceed with great caution. They must look carefully to their credits; they must not manufacture goods without understanding the conditions of these markets; they must not overstock, nor put too large a portion of their capital into this field: they must be prepared to take losses and look for a larger proportion of losses than in the territory with which they are already familiar. Crusading for business of this character is expensive. It means no immediate profit. It is an investment which will yield dividends in the distant future. In short, it is the sort of business which can only be handled by rich, well established, prosperous concerns, which take it on as a side line, and which go into it upon the assumption that it is not an El Dorado, but that it involves a long and perhaps expensive campaign, the profits of which may be delayed for years.
But we have wandered somewhat from the subject of foreign liquidation. Those little versed in financial matters believed that this liquidation would come suddenly, in a day or a week, and that for this reason the exchanges could not be opened. The fact that the opening of our stock exchanges has not brought out a deluge of securities, such as overwhelmed them in the last days of July, is taken by some people as a proof that no liquidation will occur. Both assumptions are contrary to good sense and to the normal operations of finance. The tremendous outpouring of securities which became so embarrassing a few hours before the outbreak of the European struggle, was the result of an entirely different situation than that which prevails at the present time. A good deal of it was the work of speculators who had been carrying margin accounts and who, becoming frightened at the war clouds overhanging Europe, decided to seek safety. A large share of it was prompted by the desire of foreign financial institutions and commercial interests to make preparation for the storm which had so suddenly brewed. It was apparent if war should come that a period of isolation, uncertainty and ruin would follow. Far-sighted financiers thought that a credit balance in the United States would be of assistance both in settling transactions already entered into, and in connection with future problems, after present-day obligations had been handled. The Bank of England was caught unprepared. Its gold reserve was dangerously low, compared with the burden which it must suddenly assume. Gold instead of coming to it, was being withdrawn, and it was evident that drastic steps for the replenishment of the gold stock were necessary. Thus we had general moratoria and the calling of short-time loans which American bankers have habitually made during the summer against credits to be built up through the sale of cotton and grain during the fall, and which normally amounted to $400,000,000 and upwards at the end of July. The clearing up of this current borrowing has really been the object of the conferences between the representatives of the British treasury and American bankers.
The editors of The Commercial and Financial Chronicle and of a few other publications have performed a notable service in pointing out the unfairness of England's position with reference to this current indebtedness. Shielding herself behind a moratorium—a self-declared stay-law—postponing indebtedness without regard to the necessities or the desires of her creditors, and at the same time demanding of us the repayment of our obligations on the day when due, and in gold, she has, to a large degree, emphasized and intensified the disorganization which the war would cause, and has, by this purely arbitrary and one-sided arrangement, drawn from us practically all of the gold with which the position of the Bank of England has been bolstered up. I wish to reassert, in the strongest possible terms, the very wise position which these authorities have taken, that we must not play a maudlin and uncertain part with reference to the further exportation of gold. Our financial system is undergoing a radical change—a long-delayed readjustment—and it is suicidal for us, as a nation, to so manage our affairs that we shall be forced to continue to ship abroad additional amounts of gold.
Now that our current indebtedness has been satisfactorily adjusted, the only likelihood of a further withdrawal of gold will come from a liquidation of securities. Having postponed the opening of our stock exchanges until this current indebtedness was adjusted, it is reasonable to conclude that this fear of a wholesale liquidation has been very much exaggerated and that, as a continuing menace, it has been unduly magnified. I am confident that if the stock exchanges and banks cooperate in an intelligent and unselfish manner, foreign liquidation can be controlled according to our desires and convenience. If it becomes known abroad that it is the unalterable decision of American bankers that they will not enter upon or continue in any enterprise which involves the exportation of additional sums of gold, the greatest danger through foreign liquidation will have passed.
Broadly speaking, the only gain which foreign interests can achieve from selling American securities is either to obtain gold from us, with which to purchase in some other market, or in order to build up a credit balance in this country, against which they may draw in payment for merchandise, foodstuffs and munitions of war bought from American manufacturers or exporters. When we shut the door on gold exportation—and it is possible to do so—then we have nothing to fear from the sale of American securities, in order that funds may be secured to purchase American commodities. We will be selling commodities at our own price—at a good profit—and buying securities, representing ownership in properties untouched by the war, at bargain prices. We have everything to gain and nothing to lose, providing we, as a nation, can regulate the extent of the transaction.
Perhaps there are some who will feel that this is a selfish position for us to take. There has been a great deal of misapprehension concerning the ethics which should determine our position with reference to repurchasing securities owned by foreign investors. In so far as this misapprehension is the result of overwrought sympathy for this or that belligerent, no comment is necessary, but so much of it as proceeds from an honest and sane misapprehension warrants respect and attention. We must remember that the foreign holdings of American securities represent the accumulation of half a century. To ask us to repurchase the securities which we have sold during fifty years in one year, much less in a day or a month, is preposterous. A considerable part of the difficulty which many people experience is the result of fundamental misapprehension as to the nature of these securities. They do not distinguish between securities and money. No one will dispute that if foreign investors held a large amount of American paper money. this must be redeemed upon demand, no matter what sacrifices this would entail. The essential characteristic of paper money is that it shall be redeemed without question upon demand, but paper money and securities are entirely different. The first is a call for a standard dollar—that is gold; the second is a certificate of proportionate interest in either the mortgage on a property, or in the ownership of that property, as the case may be.
No one would ask that an American householder should repay the mortgage upon his home, which, by its terms, was not due for some years, simply because the English holder of the mortgage suddenly decided that he wanted his money to assist his government in prosecuting the war. No one would contend that it was the duty of the ranch owners of Texas, for example, to repurchase a ranch owned by British interests, solely because of the problems which the war brought to the foreign owners, and yet this is exactly the position which they take with reference to the stocks and bonds of our American corporations. The foreign security holder is either a creditor or a partner in our enterprises. He has gone into them with the expectation of profit and with the assurance that his money is safe. We have done nothing to endanger the safety of his investment, and whatever unfavorable features may have developed concerning the profits of the enterprise arise largely out of the war, which we have not caused and from which we are an innocent sufferer.
There is no moral obligation on our part to repurchase these securities. Such a contention proceeds upon the assumption that we have made an enormous call loan in Europe, and that it is understood upon both sides that Europe may and will call for its repayment whenever home conditions make it advisable. Such a contention is utter folly. American financiers would never have entered into such an-arrangement, and had they been so foolish as to make such enormous call loans, they would have demanded the rate of interest which properly attaches to such a class of loans. The plain truth of the matter is, that Europe has never regarded these investments as call loans. They were made because of the attractive rates of interest which they offered—from 50 to 100 per cent, higher than the rates which could be commanded for call loans. Our European friends have made the extra profit of a permanent investment, and they must now abide by their choice and convert their investment into liquid funds at our pleasure and not theirs.
If we agree as to the ideal and purpose which should be followed with reference to our financial relations with Europe, let us see to what extent this ideal can be achieved. In the beginning there is nothing mysterious or magical about the entire situation. So long as Europe does business according to the terms of her contracts with us rather than postponing payment by moratoria, most of which have now happily ended, there is no reason to fear a further and considerable exportation of gold, in so far as the purchase and sale of commodities are concerned. On the contrary, the likelihood is that, aside from the securities problem, the movement of gold would tend in the opposite direction. Incomplete trade statistics show that the trade balance is running heavily in our favor, and that if present tendencies continue the balance of trade in favor of the United States will run considerably higher than in ordinary years. This is in part due to the prostration of European manufacturing industries, which has led to a reduction in our imports, and is in part the result of increasing exports of food stuffs and certain classes of manufactured goods, the demand for which has been stimulated by the war.
We must bear in mind that the United States, being a debtor nation, must normally have a surplus of merchandise exports over imports, if the exportation of gold is to be avoided. Estimates by leading authorities on foreign trade and foreign exchange agree that this excess of merchandise exports over imports must range somewhere between $400,000,000 and $600,000,000, in order that we may be able to square our accounts without the shipment of the precious metals. This excess of merchandise exports, whatever may be the correct figure, is needed to enable us to pay interest and dividends on foreign security holdings of from $200,000,000 to $300,000,000; the expenditures of our tourists abroad, estimated at $150,000,000 to $200,000,000; the remittances by Americans to friends and relatives in European countries, estimated at $100,000,000 to $150,000,000; and payments to foreign ship owners for freight, estimated at $20,000,000 to $40,000,000. With our merchandise exports running above normal and our imports running considerably below normal; with a likelihood that tourists' expenditures during the coming summer will practically disappear; and with the encouraging news that remittances in the past few months by persons in this country to friends and relatives abroad have materially decreased, it seems altogether probable that we shall have a real excess balance in the neighborhood of $300,000,000 a year which can be used for the repurchase of American securities.
As the war develops and the, need of foreign nations for munitions and supplies increases, due to the exhaustion of stores accumulated in peaceful times, it is reasonable to presume that our exports of merchandise may still further increase, and that our ability to absorb foreign held securities will correspondingly grow. There is no more reason why it would be wise for us to demand the return of gold for our credit balances than it would be for Europe to continue to draw upon our store of gold.
If we are correct that our commercial balance of trade is satisfactory, there only remains for consideration the possibility of achieving the ideal of controlling foreign liquidation in American securities upon our own terms rather than upon theirs. I believe that this is possible, and may be accomplished, provided there is the proper degree of cooperation on the part of the stock-exchange interests, our bankers and our corporations. We must bear in mind that our stock exchanges are working on a basis of minimum prices. We have already seen, in a modified form, the efficacy of this device. A heavy selling movement will force a stock down to the minimum price, as, for example, was the case on several occasions with Steel common. When this occurs, selling ceases or must be limited to the ability of the market to absorb the stock at the minimum price. In other words, the buying movement determines the amount which shall be sold. The seller can not offer his stock at lower prices and force the financial interests, in self defence, to purchase. It is altogether likely that minimum prices will continue to be readjusted, some advanced and others lowered. The existence of minimum prices will be of the greatest advantage in controlling unwelcome liquidation. Should additional checks be found necessary they can be speedily devised and applied. Stock exchange members could be required, for example, to guarantee that securities sold by them are not for the account of citizens of belligerent nations, that at the time of sale the brokers actually possess or control the securities (which can be made effective by requiring the broker to give the numbers of the stock certificates or the bonds at the time of the sale). Most of these devices are successfully used in London.
When it becomes certain, as it should speedily appear, that the fear of uncontrollable liquidation of American securities is groundless, so long as we manage our affairs with intelligence, the investment situation in this country will rapidly improve. It is idle to presume that the amount of money available for investment in new issues of American securities will be as great as heretofore. It is altogether likely that the amount of European capital in this country, entirely aside from the resale of securities to us, will markedly decrease. It is estimated that the outstanding funded obligations of the leading railway and industrial corporations of this country that must be met at various dates throughout the next three years are $1,241,573,536, of which $764,424,289, or more than one half, is due in 1915. Our first task is to make provision for refunding or extending these maturing obligations. A certain percentage—no one seems to know how much, although the percentage is probably comparatively small—is held by foreign investors. It is altogether likely that part of the liquidation, so much feared, will consist in a demand for the repayment of these obligations as they mature. Most of them were sold at a price below par. The issuing corporations are obliged to redeem them at par. It is obviously more advantageous, to demand the payment of these securities at par than to sell us other securities at prices much below par. We have already seen something of the working out of this proposition in the recent refunding of the City of New York's obligations, where this tendency was strikingly apparent.
The refunding of outstanding loans should provide a considerable activity in securities during the year 1915. If we act intelligently and set our face against foreign liquidation of American securities there is no reason to presume that a fairly good security market will not exist. The most salable securities will be short, time obligations of municipalities, and of corporations whose earning power has been tested and found satisfactory. I refer not only to short-time notes, but bonds with five-to fifteen-year maturities. If our municipalities will borrow only for productive purposes, or where the need for additional public facilities is really existent, if they will put out short-time securities, or are willing to pay higher rates of interest, it is altogether likely that the municipal bond market will show considerable activity.
If it were possible at this time to cut out the sale of wild-cat and relatively worthless securities, the extermination of which is the aim of all blue-sky legislation, we should, to a large degree, solve our immediate problem as regards new capital. No one can tell the enormous aggregate capital which is lost every year through the sale of securities promising large returns, which are never achieved. The problem of the security market consists largely in the weeding out of these undesirable "securities." In other words, in making good the loss of our foreign clientele, practically all of whom go into our better-class securities, we must turn the stream of money now wasted in worthless schemes into this channel. Perhaps one of the few permanent benefits of the war may be that it will bring about a conservation of investment funds.
It may be remarked in conclusion that as the war progresses and the financial exhaustion of the belligerents becomes more marked the danger of liquidation will steadily increase. As some one said, the belligerents of Europe have passed through the honeymoon stage of their war financing. The Bank of France, without any increase in its gold reserve, has expanded its note issue 3,300,000,000 francs—roughly the amount of its advances to the French government. There has been a tremendous expansion both in note issues and in the deposit credit structure of the Bank of England, the Imperial Bank of Germany, in Russia and in the Netherlands. The situation is feverish to say the least. It behooves us to proceed with caution, to maintain our insular position, not only in a political, but in a financial sense; to keep our own needs and interests always in the forefront. The longer the struggle, the greater the tendency of a financial cataclysm, and even though the world succeeds in avoiding this added misfortune, while the war continues, the financial problems of peace have many times proved more difficult of solution that those of financing the struggle.
- The italics are mine.