Economics and The Public Welfare

Chapter 40

The Intergovernmental Debts

The legacy of World War I in the form of vast reparations debts and vast Inter-Allied debts proved to be one of the major causes of the failure to restore a sound economic equilibrium in the 1920’s, and one of the major causes of the breakdown of international credit in 1931 and 1932. The reparations problem we have discussed in our chapters dealing with Germany. References have been made from time to time to the Inter-Allied debts.

Our European Allies, chiefly Great Britain, France, Italy, and Belgium, owed us approximately 10 billion dollars for advances made by our Government between April of 1917, and June 30, 1919. Interest on these advances was to be at 5%. The terms of the contract, however, provided that at any time the Government of the United States might call upon the borrowers to fund these debts in marketable bonds bearing interest at a rate not lower than the highest rate paid by our Government on bonds issued to the American people during the war, which proved to be the 4 1/4% rate of the Fourth Liberty Loan. The sum grew by the accrual of interest at 5%.

In addition there was a debt of something over 400 million dollars due from the French Government to the American Government for war supplies which we sold to France at the end of the war. The French Government always made a distinction between this debt and the rest of the debt. The debt for the war stores was known as the “commercial debt,” and the other, much greater, debt was known as the “political debt.” In addition there was a debt from Germany to the American Government to cover the expenses of the American army of occupation.

There were also debts of great magnitude from France and other Continental Allies to the British Treasury. And there were other reparation debts. Bulgaria, for example, had one, and Hungary did. In 1926 the Bulgarian National Bank tried, through an Italian bank intermediary, to borrow in New York a sum which, on examination, proved to be approximately the amount of the reparations for that year, and also approximately the amount by which its gold and foreign exchange reserve had declined in the preceding twelve months. When this was pointed out to the Italian bank (which had proposed to share the risk in a “joint account” arrangement), that bank lost interest in the loan! But the items which made the most trouble were the reparations due from Germany to France, Britain, Belgium, and Italy, and the debts due from Britain, France, Italy, and Belgium to the United States.

Our Government from time to time in 1921 and 1922 reminded the governments of our European Allies of the existence of these debts, but only Great Britain felt itself in a position to do anything about the matter. There was a great deal of discussion of the equities in the matter. On the part of the French, it was urged that we ought to take account of the fact that Germany was not paying reparations. Our Government took the position that there was no connection between French receipt of reparations and the French obligation to pay the United States Government. The latter was a matter of contract which contained no provision regarding reparations and which had no provisions covering contingencies.

Our Debt Funding Commission Created, February, IÇ22. On February 9, 1922, we created a Debt Funding Commission, headed by the Secretary of the Treasury, Mr. Mellon. Another member was the Secretary of State, Mr. Hughes. A third was the Chairman of the Senate Finance Committee, Senator Reed Smoot. There were other able members, including the Secretary of Commerce, Mr. Hoover, and Representatives Theodore E. Burton and Charles R. Crisp. It was a distinguished Commission. The Debt Funding Commission was not empowered to reduce, modify, or cancel any of the debt, and the only conclusive bargains which it could work out with Europe would be on the basis of interest at 4 1/4% and maturity at the end of twenty-five years. The first impression was that the Commission would be able to do nothing. But the Commission properly conceived as its function to explore every possibility and to entertain every possible proposal. It could not settle anything itself, but it could recommend a settlement to the Congress of the United States.

Reginald McKenna’s Speech, October, 1922. In October of 1922 the Right Honorable Reginald McKenna, Chairman of the London Joint City and Midland Bank, Limited, spoke before the American Bankers’ Association at its annual meeting in New York. His speech was supposed to represent the official views of the British Government. McKenna took the position that heavy payments of intergovernmental debts made through exports of goods were not to be expected in peacetime, and that the extent to which payments could be made depended upon the volume of available liquid international securities held by the debtor countries. Great Britain, he maintained, had internationally valid foreign securities in adequate volume, and consequently could and would surely pay. He did not believe, however, that our Continental Allies could pay very much because they had used up virtually all their liquid securities. Britain was saying, “We can pay and we will pay, but don’t expect much from the Continent; be generous in your dealing with the Continent.”

The British Too Proud to Ask Adequate Concessions—The British Settlement. The British were superb in this. They were proud. They asked little consideration. When they came to deal with our Debt Funding Commission, they asked two concessions. The first was that the interest rate be scaled down to 3 1/2%, because that was what Britain’s historical credit standing entitled her to. And they asked, second, that in consideration of their heavy losses during the war they be given a 3% rate for the first ten years. A schedule of payments was worked out and the British began to pay.

Britain could have had much greater concessions from us at that time if she had asked for them. She was proud. She was magnificently proud. We did what she asked.

There is one mitigating factor with respect to the British debt which makes this settlement somewhat less severe than it appears to be on its face. André Tardieu, who handled the French borrowing in Washington during the war, stated privately in early October of 1925 that of every $3 which he borrowed for France from the United States, he promptly turned over $1 to Britain in meeting French obligations to Britain. In other words, Britain got from France good American dollars during the war and early postwar period instead of the very dubious sterling obligations of France. The French debt to the United States was thus larger than would otherwise have been the case. The British debt to the United States was smaller, and the French debt to Britain was smaller.1

Even so, Britain ought to have had much more generous terms, as was clearly demonstrated by later events.

The arrangement above described with Britain was reported by the Debt Funding Commission to the Congress, which ratified it.

Belgian and Italian Settlements, 1925. Settlements with Belgium, Italy, and France came much more slowly. In 1925 our Debt Funding Commission made settlements with Belgium and Italy on terms very much more generous. The Italian payment was to start at 5 million dollars a year and was gradually to work up to 80 millions a year. Rome was jubilant.2

The French Settlement. Caillaux, in the midst of a great crisis in the franc, had also been in Washington with a commission which included Senator Bérenger and Senator Dausset, but he had made no settlement. It was reported that in the course of the transaction with the American Debt Funding Commission Senator Reed Smoot had said to Caillaux, “You are a trader.” Caillaux, whose English was not perfect, misunderstood the Senator. He thought he was being called a traitor. He had been called a traitor before, for having discussed peace terms with Germans in Switzerland while the war was on, and had had a narrow escape. He was said to have grown very vehement in his indignation until Senator Smoot’s meaning was with difficulty explained to him. But he was in no position to sign a settlement. His own government finances in France were rapidly disintegrating and the franc was in a very precarious position.3

Senator Dausset, of Caillaux’s delegation, came back from Washington to Paris aghast at the reception the French had received from the American Debt Funding Commission. He spoke of Secretary Mellon as being very hard and very unyielding. Senator Bérenger, on the other hand, spoke of Secretary Mellon with great respect and said that he had found him alert, flexible, fair, ready to explore every possibility, quick with a formula to meet the needs of the French situation, and that he felt it ought to be possible to work out readily enough a solution of the French debts as soon as French finances could be put in order.

Tardieu said that while he was getting money for France from the United States Treasury, he repeatedly said to the American authorities that he did not see how France could ever pay, and that he was repeatedly told not to worry about it, but to take the money and fight the war.

Chapter 21 contains the story of the French crisis of 1926 when the franc dropped to two cents in the foreign exchange market in July, 1926, the financial and monetary reforms introduced by Poincairé in that year, and the de facto stabilization of the franc in the neighborhood of 4¢ late in 1926. A tentative agreement on the French debt was reached in April, 1926, in the Mellon-Bérenger agreement, but it was not finally ratified by the French until 1928, and the actual gold stabilization of the franc remained unsettled, waiting for the settlement of the intergovernmental debt problem.

The French delay in ratifying the Mellon-Bérenger agreement put into sharp relief the French discussion of the “commercial debt” and the “political debt.” The commercial debt they felt they must pay. If the French Parliament were unwilling to ratify the agreement, they must still pay the commercial debt and leave the political debt floating for later discussion. They carried in gold and foreign exchange a sum equal to the “commercial debt” ready for this use. They did not feel prepared to stabilize their currency definitely against gold until they knew that this great sum of approximately 400 million dollars in gold and gold exchange could safely be added to the reserves of the Bank of France as part of the basis for stabilization.

The details of the schedules of payments of these long dead intergovernmental debts of the first war are of no interest here.

The general theory of these settlements was that we should get our principal back, and that the concessions should be made in the interest charged. The payments were to run through several decades. The British settlement alone provided for anything like full repayment, including both interest and principal. It was to run at approximately $161,000,000 a year from 1923 to 1932 inclusive, after which, with the increased rate of interest, the annual payments were to run up to $183,900,000 in 1933 and to $184,420,000 in 1937.

France, which owed almost as much as England did, was given a very much lighter schedule of payments. It was to start at $30,000,000 in 1926, all of which was to be credited to principal. Interest payments were not to begin until 1931, and then the schedule was to run up from $40,000,000 a year in 1931 to $100,000,000 a year in 1937. The Italian payments in the earlier years were to be very light: $5,000,000 from 1926 to 1930 inclusive, all of which was to be credited to principal. Then very modest interest payments were to begin, but the total of interest and principal by 1937 was to be $16,627,000. The big payments by Italy were to come later.

The schedule of payments was carried through to the Hoover Moratorium in the summer of 1931. Other chapters give an account of the Hoover Moratorium, the Hoover-Laval Agreement of late 1931, the failure to build upon this agreement in 1932, the desperate efforts of Britain and France to avoid default by working out a new settlement following the election of 1932, the failure of President Hoover and President-elect Roosevelt to cooperate in dealing with this matter, Britain’s payment in gold and France’s default (December 15, 1932), the token payments of silver under the Thomas Amendment made by Britain and certain other countries in 1933, and the final complete default on the debts, by all the countries except Finland.

Britain Remains Anxious to Effect New Settlement After Default in 1933. Britain did not cease her efforts to accomplish a settlement after Roosevelt became President. Governor Eugene Black of the Federal Reserve Board said once that Sir Ronald Lindsay, the British Ambassador, had spent two hours with him and with Mr. Oliphant of the Treasury, trying very hard to reach an adjustment. Governor Black said that his instructions were not to make an agreement and not to refuse to make an agreement. He said it had been a humiliating two hours. He added that when the session was over and newspapermen came to him and Oliphant to ask what had happened, he had said to them, “Gentlemen, I cannot tell you. You see, Sir Ronald spoke only English. You had better ask Mr. Oliphant.” Governor Black added that Mr. Oliphant’s rejoinder was most profane.

As late as 1937 unimpeachable sources in London indicated that the British still wished to settle this debt, and were prepared to undertake to make annual payments of 10 million pounds a year (50 million dollars at the current rate of exchange), if that were acceptable to the United States Government. Alternatively, they were prepared to send us I billion dollars in gold if we would let that clear the slate.

Some Lessons. The lesson is clear that we want no hangovers after World War II of intergovernmental debts that are going to put a continuing burden on the foreign exchanges through the coming decades, and that are going to be a continuing burden on the budgets of our Allies through the coming decades.

Had we made more reasonable schedules of debt payments in the years 1922 to 1928, and had we had a low tariff policy so that Europe could have paid us with goods, we could have collected. We could probably have collected even the schedules agreed upon if we had had a low tariff policy.

The time came by 1927 when the burden of debt service on the debts of Europe to private creditors in the United States was much larger than the burden of intergovernmental debt payments. But there was a great difference between private debts which grew out of income-creating investments due from merchants and industries to foreign creditors, and the debts of governments, which represented the dead horse of a war and which had to be paid out of fiscal surpluses—surpluses which did not exist in times of depression. There was, too, a great difference between debts believed to be just by individual firms and corporations which had voluntarily contracted them, and the intergovernmental debts created in the midst of desperate war needs, and believed by the peoples of the debtor countries not to be just. There was a difference, too, between debts created by warring governments to private creditors in Allied countries, and debts of these same warring countries to Allied governments. Both the peoples and the governments of the debtor countries respected their debts to private lenders, whereas they felt that they were entitled to consideration and readjustment in their financial relations with the governmental Allies.

A further point must be added as to the atmosphere in which most of these debt settlements were made. The period of the ’20’s was a period of immense bank credit expansion, as we have seen, a period in which the scarcity of real capital in the world was masked for several years by the creation of excessive bank deposits and bank loans and investments. Our Debt Funding Commission and the governments of our European debtors were both misled by this atmosphere. As a result, the schedules were placed much higher than would otherwise have been the case.

• 1This point will be discussed at length in Chap. 34.
• 2I have not been able to find that this article was ever published. However, the reader will find much of it in two books by Veblen: Imperial Germany and the Industrial Revolution, New York, 1915; and The Nature of Peace and the Terms of Its Perpetuation, New York, 1917.
• 3See my book The Effects of the War on Money, Credit and Banking in France and the United States, published by the Carnegie Endowment for International Peace, Oxford University Press, New York, 1919. For London, see the interesting articles by Mr. J. M. Keynes in the British Economic Journal in late 1914.