Financial Centers Can Shift

Today’s selection — from The End of Alchemy by Mervyn King. In 1914, just days before the outbreak of World War I, both England and America experienced a financial crisis almost as large as the Crash of 1929. Almost no one remembers it today, but it was the very moment leadership in the global financial world shifted irrevocably from London to New York. It turns out that the U.S. had learned from its 1907 crisis and had pre-authorized emergency money for just such an occasion, so handled the panic deftly. (America had unfortunately forgotten those lessons by 1929). London, however, had made no such provisions, and over five months the government spent a huge sum — equal to 5.3% of GDP — to save the banks and the economy, a gamble that could only have been approved in wartime. Coupled with its crippling expenditures on the war itself, London forever lost its financial leadership of the world:

“The outbreak of the First World War saw the biggest financial crisis in Europe, at least until the events of 2008, and an equally severe crisis in New York, albeit that the Great Depression was a bigger economic crisis in terms of its impact on output and unemployment. … Yet I found that few people knew much about the financial crisis of 1914. Even the war memoirs of the Chancellor of the Exchequer at the time, David Lloyd George, devote only fourteen out of 2108 pages to the financial crisis he faced.

“So what happened in 1914? … Just two days before Britain declared war in August 1914, the Governor of the Bank of England, Lord Cunliffe, was lunching on the yacht of the wealthy and well-connected Clark family, moored off the west coast of Scotland. … ‘There’s talk of a war,’ said Lord Cunliffe, ‘but it won’t happen. The Germans haven’t got the credits.’ … [famed economist] John Maynard Keynes too was not immune to the mood of the moment when, on 24 June 1914, he wrote to the Treasury: ‘In a modern panic it is improb­able that the big banks will come to grief.’ … It was the ultimatum from Austria to Serbia (demanding that Serbia take draconian steps to suppress the expression of nationalist opinions) on 23 July that finally changed sentiment.

Crowds gather in Throgmorton Street near the Stock Exchange following its closure on July 31, 1914

“The next two weeks saw panic in markets and among banks. European stock markets fell sharply, and several were closed. … At 10.15 a.m. on Friday 31 July the London Stock Exchange was closed in order to postpone settlement of transactions and thereby prevent a wave of failures among its members as prices plummeted.

“That same day, lines formed in Threadneedle Street outside the Bank of England as depositors queued, as was their right, to convert deposits or notes into gold sovereigns, which commer­cial banks would not provide to them. …

“Meanwhile, on the other side of the Atlantic, the position was no less precarious. … The dollar fell sharply. What happened over the next few weeks, however, was to result in New York displacing London as the money centre of the world. …

“Out of the 1907 crisis came [a] solution to the prob­lems of 1914. … Emergency banknotes, embossed with each bank’s own name and logo, worth $500 million were printed in advance and stored with the Treasury in a new underground vault. Here was a source of emergency money that could be distributed to banks in exchange for collateral without the need for a central bank. …

“In contrast with 1907, when the money supply fell by over 10 per cent, in 1914 the creation of emergency money allowed the money supply to rise at an annual rate of around 10 per cent. Demand for emergency money peaked at the end of October 1914 and fell gradually, disappearing altogether by the middle of 1915. Despite the absence of any help from the new Federal Reserve Board, not yet up and running, [U.S. Treasury Secretary] McAdoo had shown how a government could act as a lender of last resort. …

“Britain declared war on Tuesday 4 August. … [But] Britain had not learned from the US experience in 1907 and had printed no store of emergency money to distribute in a crisis.

“Over five months, Chancellor of the Exchequer [David] Lloyd George and Treasury officials recapitalised the City. … The Bank [of England] bought one-third of the entire stock of bills, amounting to some 5.3 per cent of GDP. As Lloyd George admitted in his memoirs, by offering the guarantee the government had ‘temporarily assumed immense liabilities’. He took the risk of losses on the assets he guaranteed without seeking any compensation. It was a gamble that could have been taken only in wartime.

“It worked. The City was saved.