WAR FINANCE AS IT MIGHT HAVE BEEN--I

November, 1917

Financial Conditions in August, 1914--No Scheme prepared to meet thePossibility of War--A Short Struggle expected--The Importance ofFinance as a Weapon--Labour's Example--The Economic Problem ofWar--The Advantages of Direct Taxation--The Government follows thePath of Least Resistance--The Effect of Currency Inflation.

A legend current in the City says that the Imperial War Committee, orwhatever was the august body entrusted with the task of thinking outwar problems beforehand, had done its work with regard to the Army andNavy, transport and provision, and everything else that we should wantfor the war, and were going on to the question of finance next week,when the war intervened. Whatever may be the truth of this story, theevents of the war confirm the opinion that if it was not true it oughtto have been. We are continually accused of not having been ready forthe war; but, in fact, we were quite ready to do everything that wehad promised to do with regard to military and naval operations. OurNavy was ready in its place in the fighting line, and the dispatchwith which our Expeditionary Force was collected from all parts of thekingdom, and shipped across to France, was a miracle of efficiency andpractical organisation. It is true that we had not got an Army on aContinental scale, but it was no part of our contract that we shouldhave one. The fighting on land was in those days expected to be doneby our Allies, assisted by a small British force on the left flank ofthe French Army. That British force was duly there, and circumstanceswhich were quite unforeseen made it necessary for us to undertake atask which was no part of our original programme and create an Armyon a Continental scale, in addition to doing everything that we hadpromised beforehand to a much greater extent than was in the bargain.

But in finance there was no evidence that any thought-out policy hadbeen arrived at in order to make the best possible use of the nation'seconomic resources for the war when it came. The acute crisis in theCity which occurred in August, 1914, was a minor matter which hardlyaffected the subsequent history of our war finance except by givingdangerous evidence of the ease by which financial problems can beapparently surmounted by the simple method of creating bankingcredits. That crisis merely arose from the fact that we were sostrong financially, and had so great a hold upon the finance of othercountries in the world, that when we decided, owing to stress of war,to leave off lending to foreigners and to call in loans that we hadmade by way of accepting and bill-discounting arrangements, the wholemachinery of exchange broke down because from all over the world themarket in exchange went one way. Everybody wanted to buy bills onLondon, and there were no bills to be had.

There was also the internal problem which arose because some of thepublic and some of the banks took to the evil practice of hoardinggold just at the wrong moment, and consequently there was no availablesupply of legal tender currency except in the shape of Bank of Englandnotes, the smallest denomination of which is L5. It is known that ourbankers had long before pointed out to the Treasury that if ever abanking crisis arose there would, or might be, this demand for a papercurrency of smaller denominations than L5; this suggestion got into apigeon-hole at the Treasury and was deep under the dust of Whitehallby the time experience proved how big a gap in our financial armourhad been made by its neglect. If the L1 notes, with which we are nowso familiar, had been ready when the war broke out, or, still better,if the Bank of England had been empowered and instructed to have anissue of its own L1 notes ready, it may at least be contended that themoratorium, which was so bad a financial beginning of the war, mighthave been avoided.

But this opening crisis was a short-lived matter, and was promptlydealt with, thanks to the energy and courage of Mr Lloyd George, whowas then Chancellor of the Exchequer, and saw that things had to bedone quickly, and took the advice of the City as to what had to bedone. The measures then employed erred, if at all, on the side ofdoing too much, which was certainly a mistake in the right directionif in any. What is much more evident is the fact that not only hadthere been no attempt to provide against just such a jolt to ourfinancial machine as took place when the war began, but that, quiteapart from the financial machinery of the City, no reasoned andthought-out attention had been given to the great problems ofgovernmental finance which war on such a scale brought with it. Thereis, of course, the excuse that nobody expected the war to be on thisscale, or to last so long. The general view was that the strugglewould be over in a few months, and must certainly be so if for noother reason because the economic strain would be so great that thenations of Europe could not stand it for a long time. On the otherhand, we must remember that Lord Kitchener, whom most men thenregarded as representing all that was most trustworthy in militaryopinion, made arrangements from the beginning on the assumption thatthe war might last for three years. So, while some excuse may be madefor our lack of financial foresight, it does seem to have been theduty of those whose business it is to manage our finances to havethought out a complete scheme to be adopted in case of war if at anytime we should be involved in one on a European scale. Instead ofwhich, not only would it appear that no such endeavour had been madeby our Treasury experts before the war, but that no such endeavourhas ever been made by them since the war began. All through thewar's history many of the country's mistakes have been based on theencouraging conviction that the war would be over in the next sixmonths. This conviction is still cherished to this day, and there canbe no doubt that if those who cherish it hold on to it long enoughthey will come right some day.

But if delusions of this kind may be fairly excused in the man inthe street, they do not seem to be any excuse for those who areresponsible for our finance for their total lack of a thought-outscheme at the beginning of the war, and their total failure to produceone as the war went on. We have financed the war by haphazard methods,limping along the line of least resistance. We are continuing to doso, and we may do so to the end, though there are now growing signs ofan impatience both among the property-owning classes and others ofthe system by which we are financing the war by piling up debt andmanufacturing banking credits.

The objections to the policy on the part of the "haves" and the "havenots" are, of course, different, but as they both converge to thesame point, namely, to the reform of our system of war finance, it ispossible that they may in time have the effect of shaking even theconfidence of our politicians and officials in the haphazard andslipshod methods which would long ago have produced financial disasterif it had not been for the great financial strength of the country.
Finance is an enormously important weapon in the hands of our rulersfor gliding the economic activities of the people. This is so even inpeace time to a certain extent, though the revenue then collected isso small an item in the total national income that it counts for muchless than in war, when the power that the Government can wield byits policy in taxation and borrowing might have been all-powerful inkeeping the nation on the right lines in the matter of spending andkeeping down the cost of the war, and in maintaining our financialstaying power to a far greater extent than has actually been done.

It is easy, as they say on the Stock Exchange, to job backwards, andit is also easy, and perhaps rather unprofitable, to hazard opinionsabout what would have happened if things had been otherwise.Nevertheless, when we look back on the spirit of the country as it wasin those early days of the war, when the violation of Belgium had senta chivalrous thrill through the hearts of all classes in the country,when we all recognised that we were faced with the greatest crisisin our history, that our country and the future of civilisation wereabout to be tested by the severest strain ever applied to them, thatthe life and fortune of the individual did not count, but that thewar and victory were the only interests that any one had a right toconsider--when one remembers all these things, and the use that a wisefinancial policy might have made of them, it is impossible to avoidthe conclusion that the history of the war in this country and itssocial and political effects might have been something much finer,much cleaner and more noble if only the weapons of finance had beenmore boldly and wisely used. It is not a good thing to indulge inhigh-falutin' on this subject. It is absurd to suppose that the warsuddenly turned us all into plaster saints at the beginning, and thatwe might have continued so to the end if the State had dealt with ourmoney in a proper way. But without setting up any such idealisticarguments as these, looking back on those early days of the war, onecan still remember the thrill of earnestness and of eagerness forself-sacrifice which has since then given way lamentably to warprofiteering, war strikes, and a general struggle among many classesof the community to make as much as possible out of the war, merelybecause our financial leaders have never really put the country'sfinancial problem properly before the country.

We were not plaster saints, but we were either Idealistic and perhapsfoolish people who attached great importance to the freedom andsecurity of small nations and all those items in the programme ofidealistic Radicalism, or else we were good, red-hot, true-blueJingoes with a hearty hatred for Germany, and enjoyed the thought thatthe big fight which we had long foreseen between the two countries wasat last going to be fought out. Or, again, we were just commonplacepeople who did not much believe in idealistic Radicalism oranti-German bitterness, but saw that the whole future of our countrywas at stake, and were prepared to do anything for it. A fine examplewas set us in those days by the Trade Union leaders. The industrialworld was seething with discontent. The Suffragettes in London and theCarsonites in Ireland had shown us how much could be done by appealsto physical force in a lazy-minded community; and hints of industrialrevolution, with great organised strikes, which were going to tie upthe transport industry of the country were in the air. And then, whenthe war came, the Labour leaders said, "No strikes until the war isover. Our country comes first."

This was the lead given to the country by those down at the bottom,who had the least to lose, and whose patriotism during the course ofthe war has frequently been questioned. At the top the financial andproperty-owning classes, having been saved by Mr Lloyd George's ableadroitness from a bad crisis in the City, were entirely tame, andwould have suffered anything in the way of taxation or financialconscription if the need for it had been properly put before them.

It is almost amusing to remember now that in those early days of thewar the shareholders in Home Railway companies were thought lucky. TheGovernment were taking the railways over, and were guaranteeing thattheir proprietors should receive the same dividends as they had hadbefore the war. Such was the view in financial and property-owningcircles of results of war that, so far from any expectation of thehuge profits which war has put into the pockets of certain classes,they were only too thankful if they could be assured that their grossincomes were not going to be reduced.

Such was the spirit with which the Government of that day had todeal. A spirit in all classes earnestly patriotic, and so thoroughlyfrightened of the economic consequences of the war that it would havebeen ready to face any sacrifices that the Government had asked of it.How, then, would the Government have dealt with this spirit if it hadtaken the trouble really to think out the problem of war finance ona long view instead of proceeding along a haphazard line, adjustingpeace methods to war without any consideration as to their adequacy?If the problem had been really thought out beforehand the Governmentmust have seen clearly that the real economic problem in war-time isnot merely a question of raising money, since that can at any timebe done easily by means of a printing-press, but of diverting theindustrial energy of the nation from peace to war purposes, that isto say, transferring from the enjoyment of the individual citizenthe goods and services that used to contribute to his comfort andamusement, and turning them over to the provision of the things neededfor the war. War's needs can only be met out of the current productionof the world as it is at present. All the warring powers begin awar with certain accumulated war stores consisting of battleships,ammunition, guns and all other forms of war material. Apart from thesestores with which they begin, the whole work of providing the armieswith the fighting materials that they require, and the food andclothes that they consume, has to be done during the course of thewar, that is to say, out of the current production of the moment.

Therefore the real economic problem that any Government has to face inwar-time is that of inducing its citizens to reduce their purchase ofgoods and services, that is to say, to spend less, so that allthe things required for the Army and Navy may be obtained by theGovernment. It is true that some of the goods and services requiredfor carrying on war can be obtained from foreign countries by anybelligerent which is able to communicate with them freely. In thatcase the current production of the foreigner can be called in to help.But this can only be done if the warring country is able to ship goodsto the foreigner in payment for what it buys, or if it is able toobtain a loan from the foreigner, or some other foreign country, inorder to pay for its purchases abroad, or again, if, as in our case,it holds a large accumulation of securities which foreign countriesare prepared to take in exchange for goods that they send for thepurposes of the war. By these two last-named processes, raising moneyabroad, and selling securities to foreign nations, the warring countryimpoverishes itself for the future. When it borrows abroad it pledgesitself to export goods and services in future to meet interest andsinking fund on the money so raised, so getting no goods and servicesin return. When it ships its accumulated wealth in the form ofsecurities it gives up for the future any claim to goods and servicesfrom the debtor country which used to come to it to meet interest andredemption. It is only by shipping goods in return for goods importedfor the war that a country can keep its financial staying-power on aneven keel.

Thus the problem which a statesman who had thought out the economicsof war beforehand would have recognised as the keystone of his policy,would have been that of diverting the activities of the country fromproviding itself with comforts and amusements to turning out goodsrequired for war, and of doing so with the least possible friction,the least possible alteration in the economic equilibrium of thecountry, and, above all, with the least possible cost to the nationalfinances. We arrive at the true aspect of this problem more easily ifwe leave out the question of money altogether and think of it in unitsof energy. When a nation goes to war it means to say that it has toapply so many units of energy to the business of fighting, and toprovide the fighters with all that they need. If at the beginningof the war its utmost capacity of output was, to mention merely afanciful figure, a thousand million units of energy, and if it wasclear that the fighting forces of the country would need for theirproper maintenance five hundred million units of energy, then it isclear that the nation's ordinary consumption of goods and serviceswould have to be reduced to the extent of five hundred millions ofunits of energy, which would have to be applied to the war, that is,assuming that its possible output remained the same.

In other words, the spending power of the citizens of the countryhad to be reduced so that the industrial energy that used to go intomeeting their wants might be made available for the purposes offighting forces. Now what was the straightest, simplest and cleanestway of bringing about this reduction in buying power on the part ofthe ordinary citizen which has been shown to be necessary for thepurposes of war finance? Clearly the best way of doing it is bytaxation equitably imposed. When the State taxes, it says in effectto the citizens, "Your country needs certain goods and services, youtherefore will have to go without those goods and services, and thesimplest way to make you do this is to take away your money and soration your buying power. Whatever is needed for the Army and Navywill be taken away from you by taxation, and the result of this willbe that, instead of your indulging in comforts and luxuries, to theextent of the war's needs the Government will use your money forpaying for what is needed for the Army and Navy."

If such a policy had been carried out the cost of the war to thecommunity would have been enormously cheapened. There need have beenno general rise in prices because there would have been no increasein demand for goods and services. Anything that the Governmentspent would have been counter-balanced by decreased spending by theindividual; any work that the Government needed for the war would havebeen counter-balanced by a reduction in demand for work on the partof individual citizens. There would have been no multiplication ofcurrency owing to enormous credits raised by the Government; therewould have been merely a transfer of buying power from individuals tothe State. The process would have been gradual, there need have beenno acute dislocation, but as the cost of the war increased, that is tosay, as the Government needed more and more goods and services for itsprosecution, the community would gradually have shed one after anotherthe extravagances on which it spent so many hundreds of millions indays before the war. As it shed these extravagances the labourand energy needed to produce them would have been automaticallytransferred to the service of the war, or to the production ofnecessaries of life. By this simple process of monetary rationing allthe frantic appeals for economy, and most of the complicated, tangledproblems raised by such matters as Food Control or National Servicewould have been avoided.

But, it may be contended, this is setting up an ideal so absurdlytoo high that you cannot expect any modern nation to rise up to it.Perhaps this is true, though I am not at all sure that if we had had areally bold and far-sighted Finance Minister at the beginning of thewar he might not have persuaded the nation to tackle its war problemon this exalted line. At least it can be claimed that our financialrulers might have looked into the history of the matter and seen whatour ancestors had done in big wars in this matter of paying for warcosts out of taxation, with the determination to do at least as wellas they did, and perhaps rather better, owing to the overwhelmingscale of modern financial problems. If they had done so they wouldhave found that both in the Napoleonic and the Crimean wars we paidfor nearly half the cost of the war out of revenue as they went on,whereas in the present war the proportion that we are paying bytaxation, instead of being 47 per cent., as it was when our sturdyancestors fought against Napoleon, is less than 20 per cent.[1]Why has this been so? Partly, no doubt, owing to the slackness andcowardice of our politicians, and the apathy of the overworkedofficials, who have been too busy with the details of finance to thinkthe problem out on a large scale. But it is chiefly, I think, becauseour system of taxation, though probably the best in the world,involves so many inequities that it cannot be applied on a reallylarge scale without producing a discontent which might have hadserious consequences on our conduct of the war.

[Footnote 1: See _Economist_, August 4, 1917, p. 151.]

It is not possible nowadays, now that the working classes areconscious of their strength, to apply taxation to ordinary articlesof general consumption with anything like the ruthlessness which informer days produced such widespread misery. Indirect taxation of thiskind carries with it this inherent weakness that its burden falls mostheavily on those who are least able to bear it, consequently it isbound to break in the hand of those who attempt to apply it withanything like vigour to a community which is prepared to stand up forfair treatment. A tax on bread or salt obviously hits the wage-earnerat 30s. a week infinitely harder than it hits the millionaire, and sothe country would not tolerate taxes on bread or salt. Direct taxes,such as Income Tax and Death Duties, have this enormous advantage,that they can really be regulated so as to press with continuallyincreasing severity upon those who are best able to bear them.Unfortunately our Income Tax is still so unjustly imposed that it wasclearly impossible to make full use of it without its being firstreformed. That two men, each earning L1000 a year, should pay the sameIncome Tax, in spite of one having a wife and five children, whilethe other is a careless bachelor, is such a blot upon this otherwiseexcellent tax that it is generally agreed that the present rate of 5s.is as high as it can be made to go unless some reform is introducedinto its incidence. The need for its reform is made the excuse for asparing use of the tax, and we have been on several occasions assuredthat, as soon as the war is over, this reform will be set about.
In the meantime the Government falls back on funding about 80 percent. of its requirements of the war on a system of borrowing. Inso far as the money subscribed to its loans is money that is beinggenuinely saved by investors this process has exactly the same effectas taxation, that is to say, somebody goes without goods and servicesand hands over his power to buy them to the State to be used for thewar. Borrowing of this kind consequently does everything that isneeded for the solution of the immediate war problem, and the onlyobjection to it is that it leaves later on the difficulties involvedby raising taxes when the war is over, and economic problems aremuch more complicated in times of peace than in war, for meeting theinterest and redemption of debt. But, in fact, it is well known thatby no means all that the Government has borrowed for war purposes hasbeen provided in this way. Much of the money that the Government hasobtained for war purposes has been got not out of genuine savingsof investors, but by arrangements of various kinds with the bankingmachinery of the country, or by the simple use of the printing-press,with the result that the Government has provided itself with anenormous mass of new currency which has not been taken out of anybodyelse's pocket, but has been manufactured by or for the Government.

The consequence of the profligate use of this dishonest process isthat general rise in prices, which is in effect an indirect tax on thenecessaries of life, involving all the injustice and ill-feeling whicharises from such a measure. It is inevitable that the working classes,finding themselves subjected to a rise in prices, the cause of whichthey do not understand, but the result of which they see to be a greatdecrease in the buying power of their wages, should believe that theyare being exploited by profiteers, that the rich classes are growingricher at their expense out of the war, and that they and the countryare being bled by a set of unpatriotic capitalist blood-suckers. Itis also natural that the property-owning classes, who find themselvespaying an Income Tax which they regard as extortionate, shouldconsider that the working classes by their continuous demands forhigher wages to meet higher cost of living, are trying to exploitthe country in their own interests in a time of national crisis, anddisplaying a most unedifying spirit. The social result of this evilpolicy of inflation, in embittering class against class, is a matterwhich it is difficult to exaggerate. Some people think that it wasinevitable. This is too wide a question to be entered into now, butat least it must be contended that if it is inevitable the extent towhich it is being practised might have been very greatly diminished.

Do we mean to go on to the end of the war with this muddling policy ofbad finance? If we still insist on believing that the war cannot lastanother six months, and there is therefore no need to pull ourselvesup short financially and put things in order, then we certainly shalldo so. But we should surely recognise that there is at least a chancethat the war may go on for years, that if so our present financialmethods will leave us with a burden of debt which is appalling toconsider, and that in any case, whether the war lasts another sixmonths or another six years, a reform of our financial methods is longoverdue, is inevitable some time, and will pay us better the sooner itis set about.