NO GREAT WAR EVER BROKE OUT so unexpectedly or for so trivial a reason as the First World War.
To be sure, the Great Powers of Europe had been in an arms race for several years and a series of crises had threatened the peace. In 1912 the First Balkan War, when Serbia and Bulgaria declared war on Turkey, threatened to bring in Austria and Russia and ignite a general conflagration. The reaction of the world’s markets had been immediate and profound: they all declined abruptly. Interest rates rose. Gold began to flow out of the United States as European central banks liquidated overseas investments and repatriated assets. The crisis soon passed, however, when Russia backed down.
But while the Western world was fearful, many thoughtful people held that Great Power wars were a thing of the past. There hadn’t been one in almost half a century. Norman Angell, who would win the Nobel Peace Prize, argued in his very influential book The Grand Illusion, published in 1910, that the inevitable disruption of international credit would make it impossible to finance such wars, or would at least bring them to a very speedy conclusion. One economist, writing in the New York Times in 1914, wrote that “no modern war has been conducted to which the business world as a whole was unalterably opposed, for war must draw its sinews from the money chests of business.”
So the news of the assassination of the Archduke Franz Ferdinand, heir to the throne of Austria-Hungary, on June 28, 1914, did not raise immediate fears. But Austria, the weakest of the Great Powers, was determined to extract political advantage out of the situation and demanded concessions from Serbia, where the assassination had taken place. Russia, the main Slavic power, backed Serbia and threatened to mobilize its forces. Kaiser Wilhelm II of Germany, who could have defused the situation at any time by reining in Austria, backed it instead.
On July 28 Russia began to mobilize, and events quickly spiraled out of control. Mobilizing armies in the age of the railroad required elaborate and detailed planning. And once mobilization was initiated it could not be reversed without effectively rendering a country defenseless. When the German ultimatum to Russia to cease preparations on its frontier expired on August 1, Germany declared war, and within four days all the Great Powers of Europe were at war. It would be four years, three months, and eight million dead soldiers before peace returned to Europe.
And that continent, the center of the Western world for twenty-five hundred years, would lose far more than a generation of its young men. When the war was finally over, the only winner, in geopolitical terms, would be the United States, which would become by far the strongest nation on earth and the new center of the Western world.
AS THE THREAT OF WAR became ever greater in the last days of July 1914, stock markets the world over panicked while the demand for gold soared. On Tuesday, July 28, unable to maintain orderly markets, the exchanges in Vienna, Rome, and Berlin closed. The next day volume on the New York Stock Exchange reached 1.3 million shares, its highest since the panic of 1907, and many leading stocks fell more than 20 percent. On Friday, July 31, the London Stock Exchange closed for the first time in its history, and New York was the only major exchange scheduled to open the next day.
It had no real choice except to close as well. With the world’s markets now tied together with a cat’s cradle of undersea cables, sellers converged on New York, and sell orders began piling up in mountains awaiting the Saturday opening. (The New York Stock Exchange would have a Saturday morning session until after the Second World War.) The governors voted to close the exchange, and the president of the exchange consulted J. P. Morgan, Jr., now head of the House of Morgan, and the secretary of the treasury, William Gibbs McAdoo. They agreed, and the New York Stock Exchange closed and suspended deliveries until further notice.
It would be December before the exchange reopened, and then on a limited basis. On December 30, 1914, the exchange traded a mere 49,937 shares, the lowest volume of the twentieth century. It was the following April before trading was fully back to normal. By then the situation had changed radically. Nearly all the conventional wisdom regarding the financial and economic effects of a major European war on the United States had proved to be wrong.
The banks had remained opened after the stock exchange had closed, and there were heavy withdrawals, mostly in gold. But these ceased by September, when movement on the Western Front also largely ceased. By the end of that month gold was flowing into New York for safekeeping, and much of it has remained there ever since, now stored eighty-five feet below the Federal Reserve bank on Liberty Street in vaults blasted out of the Manhattan bedrock.
At first American commerce was severely disrupted. Cotton exports declined sharply and so did wheat. Germany had imported 2.6 million bushels of wheat in July, but none in August, as the Royal Navy asserted its sea power.
Soon, however, the situation reversed, and American exports of agricultural products rose quickly. Part of the reason was the poor European harvest that year, which would have assured good exports for American farmers regardless of the war. But more important, with Germany controlling the Baltic, and Turkey, soon Germany’s ally, closing off commerce through the Black Sea, Russian exports of grain fell to nearly nothing. Russia had been one of the world’s leading exporters of grain in the late nineteenth century, but its share of the world market was quickly taken by the United States, Canada, Argentina, and Australia. It has never recovered it, thanks in large part, of course, to the ruination of Russian agriculture by Communism.
Between December 1913 and April 1914 the United States had exported a total of eighteen million bushels of wheat. In the same period a year later, wheat exports amounted to ninety-eight million bushels. As the war dragged on and more and more agricultural workers were called to military service in Europe, American agricultural exports continued to increase. Net farm income in the war years more than doubled, to $10 billion, and the value of agricultural land, buildings, and equipment increased by nearly 30 percent.
American manufacturing also increased rapidly. Markets in Latin America and Asia, which had been served by European companies, were now open to be taken over by American firms. Far more important was the avalanche of orders that began to roll in to American firms from Great Britain and its allies, for steel, vehicles, railroad rolling stock, and rails. An American invention of the 1870s to help tame the new western farmlands at low cost—barbed wire—was ordered by the combatants by the hundreds of thousands of miles to protect the trenches against infantry assault.
Munitions, of course, were in the greatest demand by the British, French, and Italian militaries. Du Pont had been only a midsized manufacturer of gunpowder before the war, but would come to supply the Allies with fully 40 percent of their munitions. In the four years of the war, Du Pont’s military business increased by a factor of 276. And it became one of the world’s largest chemical companies as well. Germany had dominated the world’s chemical industry in the decades before the war, but it lost its export market with the Royal Navy’s blockade. Du Pont and other American chemical companies quickly seized that vast market. By the end of the war, Du Pont had annual revenues twenty-six times as large as they had been in 1913.
Bethlehem Steel, a major armor plate manufacturer and shipbuilder, had never had a foreign contract larger than $10 million, but in November 1914 the British Admiralty offered it a contract for $135 million worth of ships, guns, and submarines. The German government, unable to tap into American industrial capacity, tried to deny it to its enemies by buying it. In 1915 it offered Charles Schwab, president and principal stockholder in Bethlehem Steel, twice the market value of his stock for control of the company. Britain, able to read German diplomatic communications, learned of the bid and was prepared to make a counter-offer. But Schwab assured the British that he would fulfill his contracts and turned down the German offer out of hand.
Overall, the gross national product of the United States increased by 21 percent in the four years of the war, while manufacturing increased by 25 percent.
The country had been in recession in 1914, but thanks to the slaughter in Europe, American industry began to prosper as it had not since the Civil War. The effect of this sudden growth was soon felt on Wall Street, and the Dow-Jones Industrial Average had the biggest annual percentage gain in its history, 86 percent, in 1915. General Motors, then the second largest American automobile company, had seen its stock plummet 39 percent in the last day of trading before the New York Stock Exchange closed on August 1, to 39. By the end of the year, with orders for vehicles pouring in, it had rebounded to 811/2. A year later GM stock stood at 500. Bethlehem Steel’s stock increased tenfold in 1915.
Early in that year the British government signed an agreement with J. P. Morgan and Company, making the bank the American purchasing agent for the British government. Its first deal was for $12 million worth of horses, which were desperately needed to move artillery and supplies at the front. (The extremely high prices paid for horses in the war years was a prime reason that tractors so quickly replaced them on American farms at this time.) The bank soon signed a similar agreement with the French government.
No one had any idea at the beginning of the war how much the Allies would purchase in the United States for the war effort, but the British secretary of state for war, Lord Kitchener, thought it might be no more than $50 million. In fact, it would amount to more than $3 billion, more than four times total federal government revenues in 1916. The Morgan Bank’s influence on American industry in these years, thanks to its immense buying power, was considerable, and Morgan had a staff of 175 working on finding needed supplies and arranging shipping and insurance.
The vast imports of war matériel by the belligerent powers had to be paid for, of course, and that was no easy matter. Britain’s annual defense budget in the immediate prewar years had averaged 50 million pounds. It was soon spending 5 million pounds a day to fight the war.
Britain, long the major supplier of capital to the developing American economy, now began to liquidate its American investments. It put a special tax on the dividends of American securities but allowed British taxpayers to pay their income taxes with U.S. securities at face value. The British treasury then turned the securities over to the Morgan Bank, which managed to sell them quietly and without adversely impacting stock values. About 70 percent of the American securities held by French and British citizens were liquidated by the end of the war.
Still, liquidating American investments provided nowhere near enough money to prosecute the war, and both the British and French governments sought American loans. The Wilson administration, especially the secretary of state, William Jennings Bryan, at first opposed any loans to the belligerent powers, Bryan calling them “the worst of contrabands.” But Bryan, a profound isolationist and intellectually inflexible, did not last long as secretary of state once the war broke out. His successor, Robert Lansing, managed to convince Wilson that loans were necessary to ensure continued economic expansion here at home.
In September 1915 the Morgan Bank arranged a loan of $500 million for the British government, far and away the largest bank loan in history up to that point, but only the beginning, it turned out. By the time the United States entered the war, Morgan had arranged loans equaling $1.5 billion to Britain and more to France. After the United States entered the war, the federal government took over as the major lender to the Allies. Altogether the government would loan the Allies $9.6 billion, a sum equal to eight times the entire American national debt in 1916.
DESPITE THE MASSIVE FINANCIAL and industrial aid, by 1917 it was becoming clear that the Allies were in deep trouble. The sinking of British merchant ships by the German submarines was threatening starvation in Britain, while the French army was near mutiny. With the fall of the czarist regime in Russia in March of that year, the possibility that the Allies might lose the war was becoming very real.
German behavior in the war, such as the violation of Belgian neutrality and the sinking of the unarmed passenger liner Lusitania—skillfully exploited by brilliant British propaganda—had turned American public opinion sharply against the Central Powers. The resumption of unrestricted submarine warfare in January 1917 proved the final straw for President Wilson, and he broke off diplomatic relations with Germany at that time.
A month later the so-called Zimmermann telegram, promising Mexico the return of its “lost provinces” in exchange for a declaration of war against the United States should war break out between the United States and Germany, became public. American public opinion was outraged. Wilson, who had run for reelection in 1916 on the slogan “He kept us out of war,” asked Congress for a declaration of war less than a month after his second term began.
With America in the fight, the extraordinary capacity of the American nation to respond to military necessity quickly became apparent. The army had numbered only two hundred thousand before the war, but by November 1918 there would be two million American soldiers in Europe, together with forty thousand cars and trucks (plus forty-five thousand horses) and two thousand airplanes.
The war’s effect on federal finances was both great and permanent, just as the Civil War’s had been. Since 1865 the government had never spent more in one year than the $746 million it had spent in 1915. The national debt that year was a mere $1.191 billion ( John D. Rockefeller could have paid it off all by himself and still have been the richest man in the country). After the First World War, however, annual government outlays were never less than $2.9 billion, and the national debt rose to more than $25 billion in 1919.
Bond drives using techniques invented by Jay Cooke during the Civil War were quickly implemented, now with the addition of using movie stars such as Douglas Fairbanks, Mary Pickford, and Charlie Chaplin to entice citizens into buying Liberty Bonds.
And the income tax, which had been a mere social-engineering device to get the rich to share more of the tax burden, began to bite into the middle class. The personal exemption, which had been at $3,000, was dropped to $1,000. The tax rate, a mere 7 percent on incomes more than $500,000 before the war, rose to 77 percent. The income tax thus became the most important source of federal revenues, as it has remained ever since. And this changed the nature of the endless debate over taxes.
When the tariff had been the primary source of federal revenues, the debate was between sections of the country. New England mill owners and their workers both favored high tariffs on cloth. Southern sharecroppers and their landlords favored low tariffs. With the income tax, the debate was now between economic classes.
There was no change in the economic situation of the United States, however, that compared with its international assets and liabilities. As an undeveloped country, the United States had been a major importer of capital. To be sure, as a curious side effect of the periodic booms, panics, and deep depressions that characterized the American economy in the nineteenth century, much of this imported capital eventually ended up in American hands. In boom times, capital would pour into the country to build new railroads and factories. Then, after the inevitable bust, discouraged European holders of stocks and bonds would dump the greatly depreciated securities for whatever they would fetch in the American market. As a result, the United States would end up having both the asset and the ownership of it.
Still, even as late as 1914, the United States remained the world’s largest debtor nation, with investments abroad that equaled $3.5 billion and European investments in the United States worth $7.2 billion. By the end of the war, the situation had nearly reversed, with foreigners holding $3.3 billion in American securities and Americans owning foreign investments worth $7 billion. In addition, foreign governments, principally France and Britain, owed the United States government $9.6 billion in war loans. Thus in four years, the United States had gone from being a net debtor, owing $3.7 billion, to being a net creditor that was owed a total of $12.6 billion.
The new reality of world politics was even more dramatic than what the mere figures imply. While the United States had military deaths amounting to 126,000 in the First World War, France, with a population of less than 40 million, had lost 1,357,000 young men, the British Empire, 908,000; Germany, 1,773,000; Austria, 1,200,000; Russia, 1,700,000.
Austria, shorn of its east European empire, ceased to be a Great Power. Germany, burdened with the reparations imposed by the draconian Treaty of Versailles and the deep psychological wound of seeing its incomparable army nonetheless defeated, would struggle for a decade and more before falling into the grip of the Nazis. Russia would be consumed with establishing a Communist state.
Even the nominal European victors, Britain and France, had been bled white, militarily, economically, and psychologically by the Great War. They would never again be the forces in world affairs that they had been for centuries.
Only the United States emerged from the struggle materially strengthened. It had been the world’s leading industrial power for three decades. Now it was the world’s leading financial power as well, replacing Britain in that role, and money would circle around the new financial center of gravity, Wall Street, rather than Lombard Street.
Britain, with its worldwide empire and immense foreign trade, had willingly and efficiently functioned as the world’s financial center and de facto central bank. Indeed, Britain had welcomed this role as an instrument of considerable power to wield on the world stage. But the United States, new to the world stage, and still deeply wary of the “entangling alliances” President Washington had warned against more than a hundred years earlier, was not so willing. (The United States had insisted on the odd locution of “associated power” rather than “ally,” after it declared war.)
It would take two decades and a resumption of world war before the American people would come to accept the fact that they had become, in the words of President John F. Kennedy, “by destiny not by choice, the watchmen on the walls of world freedom.”